Bond Discount

What does Bond Discount mean in American Law?

The definition of Bond Discount in the law of the United States, as defined by the lexicographer Arthur Leff in his legal dictionary is:

Bond discount (and bond premium) are adjustments made in the market price of bonds to reflect market changes, especially in the prevailing interest rates, for fixed income securities. Let us say, for example, that XYZ Corporation has sold bonds to the public bearing an interest rate of 10%. While these bonds are on the market, however, other corporate bonds, comparable in risk, are also on the market, and they offer 12% interest. Obviously, any potential purchaser would be crazy to buy the XYZ bonds “at par,” i.e., paying $10,000 for each $10,000 bond; he would then be accepting 10% when he could get 12% interest. One way to make [the] 10% bond competitive would be to change its interest rate to 12%, but it is too late for that; the bonds are out at the fixed 10% rate. So the only way to change the effective rate is to change the price at which the bond is purchased. Thus, the XYZ bonds will tend to be sold (either by the original issuer or a subsequent purchaser) for such amount under par as will yield the buyer 12% on his investment to maturity. This difference between the face amount of the bond and the amount actually paid for it is called “bond discount.”

Conversely, if an available bond offers a higher interest rate than other comparable bonds, buyers will be willing to pay more than its face amount to acquire it, which amount over the face value of the bond is called “bond premium.”