Deep Discount Bonds

Deep discount bonds are issued at par and redeemed at face value. The bondholder’s return comes from the difference between the bond issue price and the redemption value, making deep discount bonds similar to zero coupon bonds. These bonds are suitable for investors having long-term investment objectives.

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What are Deep Discount Bonds

Deep Discount Bonds (DDBs) are debt instruments that are issued at a deep discounted value and the face value is fully paid to the investors on maturity. These bonds have no coupon rate and therefore are referred to as zero interest bonds. The bondholder’s return comes entirely from the difference between the issue price and the redemption value. The maturity period of deep discounted bonds usually ranges from 10 to 30 years. It is designed to meet long term financial requirements of the investors who are not seeking immediate returns. Deep discount bonds are often grouped with zero-coupon bonds.

For instance, the face value of the bond is Rs 1 lakh. The issuer issued a deep discount bond for Rs 25,000 and redeemed it at Rs 1 lakh, having a maturity period of 20 years. The difference of Rs 75,000 is the investor’s return on bonds.

Primary Issuers of Deep Discount Bonds in India

IDBI had primarily issued deep discount bonds in India in 1996. The bond was issued at a deep discounted price of Rs 2,700 with a face value of Rs 1 lakh. It had a maturity period of 25 years. Being a callable bond, IDBI exercised a call option for early redemption in March 2002. The redemption amount per bond was Rs 12,000. SIDBI (formerly a subsidiary of IDBI) issued its own deep discount bonds and was also redeemed via a call option in February 2002.

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Features of Deep Discount Bonds

These bonds are usually issued with long maturity periods, i.e., 10 to 25 years.
The investor's profit is the difference between the discounted purchase price and the face value received at maturity.
There are no coupon payments during the holding period.
These bonds can be traded in the secondary market and therefore bondholders can sell and realize the difference between the initial investment and the market price.
The substantial difference between the lower purchase bond price and face value at maturity offers high returns and therefore is often considered a high yield bond.

Risks Associated with Deep Discount Bonds

Interest Rate Sensitivity: The market prices of deep discount bonds are generally more volatile than the market prices of regular bonds that pay interest periodically. The market price of such bonds can fluctuate significantly with the changing market interest rate.
Higher Credit Risk: Deep-discount bonds have no cash flow until maturity, unlike bonds that pay coupons throughout the maturity period. These carry an additional risk in case the issuer defaults, i.e., the investor may have no return on its investment.
Liquidity Risk: These zero-interest bonds are not actively traded in the secondary market, making exit before maturity difficult for investors. To reduce this risk, investors should invest in bonds only after reviewing their trading volumes in the secondary market.

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Who Should Invest in Deep Discount Bonds

Investors seeking long term investment with defined financial goals, i.e., education, retirement.
Investors are not seeking periodical cash flows from their investments.
Those comfortable with holding deep discount bonds till maturity.

Deep Discount Bonds vs Zero Coupon Bonds

Deep discount bonds and zero coupon bonds are similar; deep discount bonds are a more extreme form of zero-coupon bonds, characterised by deeper discounts and longer maturity periods. Investors should consider taxation on bonds, liquidity requirements, bond credit rating and financial goals before investing in bonds.

Differentiation Factor	Deep Discount Bonds	Zero-Coupon Bonds
Discount Rate	Very deep discount	Moderate to deep
Maturity Period	Usually long-term (10–30 years)	Can be short, medium, or long-term
Liquidity	Generally low in secondary markets	Relatively better liquidity
Interest Rate Risk	Very high due to longer duration	Relatively lower, varies with maturity

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FAQs

Deep discount bonds are taxable. The income from the transfer of a deep discount bond is treated as STCG or LTCG, subject to the holding period. STCG (held for 12 months or less) is taxed as per the investor’s income tax slab rate. LTCG (held for more than 12 months) is taxed @ 12.5%, without indexation benefits.

Unlike regular coupon paying bonds, deep discount bonds do not offer any periodic interest payments. It is issued at a deep discount to its face value, and the bondholder earns returns through capital appreciation at maturity.

Deep discount bonds are best suited for investors to meet long term financial requirements with no immediate income requirements. Further, investors are comfortable remaining invested until maturity. They are not ideal for investors seeking regular cash flow.

A deep discount bond is issued at a very steep discount and usually has a longer maturity period. On the other hand, a zero-coupon bond is issued at a moderate discount and can have short to medium or long-term maturity periods.

A deep discount bond is a bond issued at a deep discount to its face value and redeemed at par on maturity. These bonds have no coupon rate and, therefore, are also referred to as zero-interest bonds. The bondholder’s return comes entirely from the difference between the issue price and the redemption value.