Recent media articles have touted the tax benefits of investing in public bonds selling at discounts to face value (the dollar amount that will be received when a bond matures). The recent sharp rise in interest
rates has left bonds that were issued when rates were much lower selling at deep discounts to face
value. A $1,000 face value corporate bond issued many years ago when rates were close to zero may be
valued at $800, offering a $200 price gain when it reaches maturity. A bond’s yield to maturity reflects
the discounted price and current coupon. The price gain when the bond matures makes up for the
bond’s low coupon, bringing its yield to maturity in line with higher coupon bonds that are being issued
today. This allows investors to defer taxes because the taxes on price gains can be paid down the road
rather than being paid every year as the bond distributes income. While in some cases it may make
sense to invest in a bond selling at a discount, there are many reasons why this should not be a focal
point of an investor’s bond strategy:
