The investor in deep-discount bonds generally accepts a lower yield because of:

Question

Quizplus · Accepted Answer

Deep discount bonds generally trade at a lower yield to maturity than bonds selling at close to par. There are two reasons for this. First, a deep discount bond has almost no chance to be called away. Even if prices go up because of falling interest rates, the price is still likely to be below par value. Because of this protection against a call, the investor in deep discount bonds accepts a lower yield. Secondly, investors in deep discount bonds have the potential for higher percentage price increases (because of the low price base at which the investment is made). Additionally, if the bond is held to maturity, the gain is taxed at the capital gains tax rate. This is not true of zero-coupon bonds that are also sold at a discount from par.

The Investor in Deep-Discount Bonds Generally Accepts a Lower Yield