Deep Discount Bond
What it is:
How it works (Example):
The investor purchases the bond at a price that is below face value. The bond may be purchased at a significant discount because the coupon rate is significantly less than the market rate, or because of perceived instability of the issuing firm. Since the coupon rate is significantly less than the market rate, the price paid for the bond by the investor is significantly lower as well. The discount factors the higher risk into the price.
A zero-coupon bond is similar, but such bonds do not offer any return during the life of the bond, and then pay the holder the face value at maturity only. The discount on a zero coupon bond represents the interest that will be paid, in its entirety, on the maturity date of the bond.