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Never heard of this before, so searched in google and the results show that those are two different terminologies.
1.Deep discounted bonds.
2. Zero coupon bonds.But in question they say that, Company is looking to raise $5m through issue of 6year deep discounted zero coupon bonds.
What does these terms actually refer to and are they different from each other?
What is the coupon or interest rate on them?Deep discounted bonds are bonds issued at a price much lower than the nominal value. So, for example a company may issue bonds with a nominal value of $100 with an issue price of $50. So the investors pay $50 to buy them but then get back $100 at redemption.
Because they get such a high ‘bonus’ on redemption, the investors accept a much lower rate of interest. With zero coupon bonds they get no interest at all, but again get a very big premium on redemption.
They were very popular at one time but much less so now because there is a high risk for the investors that when the time comes for repayment the company cannot afford the repayment and goes bankrupt (so the investors end up having got nothing 🙂 )
As you told above, with deep discounted bonds, investors required rate of return will generally be lower or expect no interest with zero coupon bonds.
Then, why is that statement false in the kaplan kit with regards to deep discounted bonds?
The explanation says, the price investors buy the bonds at, reflects the risk and,hence, the required return. Thus, coupon rates are not important.Isn’t that statement true concerning deep discounted bonds?
No, I did not state that.
The interest each year (i.e. the coupon rate) is very low (or in the case of zero coupon bonds, is zero(, however the extra on redemption is very high.
So the overall return (calculated as the IRR in the normal way) is higher than for other bonds and is higher because they are more risky.
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