What Are Discount Bonds? Types, Examples & How They Work in India

The Indian fixed-income market has changed a lot in the past decade. It now offers investors a range of instruments that cater to different risk levels and yield expectations. Among these, discount bonds are a unique and attractive option. While traditional coupon-bearing bonds are well understood, discount bonds often spark interest because of their pricing structure, return method, and appeal for long-term investors who prefer predictable gains at maturity instead of regular payouts.

This guide provides a detailed look at discount bonds, discussing their mechanics, types, real-world examples, valuation methods, and importance in today’s Indian debt market. The article helps both new and experienced investors understand how these securities work and their significance.

Understanding Discount Bonds — The Concept in Depth

A discount bond is a fixed-income security sold for less than its face value, which is also called par value. Instead of giving regular interest payments, the return mainly comes from the difference between the price paid and the amount received at maturity. 

For example, if a bond with a face value of ₹1,000 is selling for ₹920 in the market, it is considered a discount instrument. When it matures, the issuer pays back the full ₹1,000, and the investor makes an ₹80 profit. This setup allows investors to gain from capital appreciation instead of coupon payments. 

The discount usually results from changes in interest rates, market demand, the issuer’s credit rating, or the bond's design. In many cases, especially with government or PSU debt issuances, the discount is intentional. It is a planned way to raise capital efficiently while offering predictable long-term returns to investors.

Why Do Bonds Trade at a Discount?

1. Impact of Interest Rates

Interest rates shape the entire reason discount bonds exist. When rates in the market climb above a bond’s coupon rate, nobody wants to buy that bond at its original price—it just doesn’t pay enough. So, the price drops. Investors won’t touch it until it finally gets cheap enough for the yield to match what the market wants. That’s when you have a discount bond. Bond prices and interest rates always move in opposite directions—one goes up, the other falls.

2. Coupon Rate versus Market Yield

If a bond offers a 6% coupon while market yields hover around 8%, an investor would naturally prefer securities delivering higher returns. Therefore, the priced-own adjustment ensures parity and restores competitiveness.

3. Credit Risk and Market Sentiment

Lower credit perception or market uncertainties can also push prices down. Investors may demand a higher yield for assuming additional risk, and the discount helps achieve this equilibrium.

4. Time to Maturity

Longer-dated securities are more sensitive to rate fluctuations, often exhibiting greater discounting when yields rise. 

In totality, these variables jointly determine bond pricing and explain the formation of discounts — whether moderate or deep.

Types of Discount Bonds in India

While the global market classifies discount instruments into several technical variants, the Indian context primarily revolves around two significant categories:

1. Regular Market-Driven Discount Bonds

These are traditional coupon-bearing bonds that usually trade at a discount because of market forces. They may offer annual or semi-annual interest payments, yet their price drops below par due to rising interest rates or shifts in liquidity conditions. For example, government securities (G-secs) and corporate bonds often trade at different discounts in the secondary market, based on changes in yield.

2. Zero-Coupon and Deep Discount Bonds

A second, structurally different category includes zero-coupon notes and their more aggressive counterpart: deep discount bonds in India. These are usually issued at significant discounts, sometimes 40 to 70% below face value, and do not pay any interest during their term. The total value at maturity represents the investor’s return.

Public sector enterprises (PSUs) and financial institutions widely use zero-coupon instruments because they are simple and effective for raising long-term capital. They offer predictable cash flows to investors who prefer a lump-sum payment at maturity instead of regular income..

Valuation Logic — How Discount Pricing Works

To understand the mechanics of discount bonds, it helps to examine how markets price future cash flows.

1. Present Value Formula

A bond’s worth is the present value (PV) of its future payments. For zero-coupon variants, this simplifies to:

PV= FV/(1+r)^n

Where
FV = Face value
r = Market discount rate
n = Years to maturity

As rates rise, the denominator increases, reducing the present value — which creates the discount.

2. Yield to Maturity (YTM)

The YTM on a discount instrument is typically higher than its nominal coupon rate because the gain comes from price appreciation. Investors calculate YTM to compare returns across different bond types and maturities.

Discount Bond Example — Numerical Illustration

Let’s consider a practical, relatable scenario:

• Face Value: ₹1,000
• Purchase Price: ₹760
• Maturity: 10 years
• Total Gain: ₹240 (ignoring tax considerations)

This discount bond example indicates that the investor receives a fixed, predictable maturity amount without annual interest. Such instruments often appeal to long-term investors such as retirees, high-income professionals and those seeking diversification within stable debt allocations.

Discount Bonds in India — Real-World Issuances

India has witnessed several noteworthy issuances in the discount and deep-discount category. Some of the most prominent include:

1. REC Deep Discount Bonds

The Rural Electrification Corporation recently launched a large program that offers heavily discounted securities to raise thousands of crores. Their issuance structure is similar to long-term, zero-coupon-style borrowings. This setup allows for infrastructure financing with predictable future repayment costs.

2. IRFC Deep Discount Debt Instruments

The Indian Railway Finance Corporation regularly issues long-term funds using structures that look like zero-coupon and deep-discount models. These funds usually target institutional investors. They provide valuable insight into how major Indian PSUs use these methods to balance cost efficiency with fundraising needs.

3. Government Securities (Occasional)

Certain Treasury Bills (T-Bills) may not always be clearly labeled as discount bonds, but they work on comparable principles. They are sold at a lower price and paid off at face value, making them similar to short-term discount securities.

Discount Bonds vs Traditional Bonds — Analytical Comparison

This comparative structure helps investors distinguish between income-oriented and growth-oriented debt allocations.

Advantages of Discount Bonds

1. Predictable Maturity Value

Since redemption is at face value, investors know precisely what they will receive at the end of the term.

2. No Reinvestment Risk

Coupon-bearing instruments require reinvestment of interest payments, often at fluctuating rates. Discount instruments eliminate this concern.

3. Capital Appreciation Model

Returns accrue through price accretion, making the instrument beneficial for those seeking long-term, compounding-aligned debt strategies.

4. Useful in Tax Planning

Depending on prevailing tax regulations, long-term capital appreciation might offer different tax implications compared to coupon income.

Risks Associated with Discount Bonds

1. Interest Rate Volatility

Prices may fluctuate sharply in response to yield movements, especially for long-duration instruments.

2. Liquidity Constraints

Secondary-market liquidity can sometimes be limited, particularly for privately issued deep-discount structures.

3. Credit Risk

Issuer credibility remains a crucial determinant of security and stability.

4. Longer Lock-In Nature-

These bonds typically suit long-horizon investors; premature exits may yield lower returns.

Suitability for Indian Investors

Discount instruments particularly benefit:

• Investors seeking low-maintenance, single-payout structures
• Long-term planners saving for education, retirement or milestones
• High-income professionals wanting predictable capital appreciation
• Conservative investors avoiding equity volatility

They serve as a valuable diversification tool within a balanced portfolio.

Conclusion

Discount bonds have made a significant impact in India’s growing debt market. Their simple structure, known maturity values, and long-term capital gains make them attractive to retail and institutional investors. Whether designed as zero-coupon instruments or influenced by market pricing, these bonds appeal to individuals looking for stability without sacrificing potential returns. 

Indian issuers like REC and IRFC have shown how large infrastructure projects can be funded through discount or deep-discount structures, highlighting their practicality and financial importance.

My Mudra: Your Trusted Partner in Smart Debt Investing

At My Mudra, we are committed to empowering Indian investors with transparent guidance and well-researched financial solutions. Our specialised advisory services in fixed-income products help individuals evaluate options like discount bonds, zero-coupon structures and corporate debt instruments based on risk appetite and financial goals.

Whether you are planning long-term wealth creation, diversifying your portfolio or exploring stable alternatives to volatile markets, My Mudra offers personalised recommendations, professional support and a simplified investment experience rooted in research and trust.

Also Read:
- Zero Coupon Bonds in India: Meaning, Rates, Tax & Best Options for 2025-26
- Different Types of Bonds in Finance India