Deep Discount Bonds: Understanding the Concept and Tax Treatment

What Are Deep Discount Bonds?

The bond market offers various instruments to suit different investor needs — from regular income seekers to long-term capital planners. Among these instruments, Deep Discount Bonds (DDBs) hold a unique place. Unlike regular bonds that pay periodic interest, these bonds are issued at a steep discount to their face value and redeemed at par value on maturity.

In India, deep discount bonds gained prominence with institutions like IDBI and ICICI issuing them in the 1990s, providing investors a simple, long-term investment option. Today, they continue to serve as an important part of the fixed-income ecosystem, particularly for those seeking structured debt exposure.

Deep Discount Bonds are a type of zero-coupon bond issued at a price significantly lower than their face (or par) value. The investor does not receive any periodic interest (coupon payments) during the bond’s tenure. Instead, the return is realized when the bond matures — as the difference between the purchase price and the redemption value.

For example, a bond with a face value of ₹10,000 might be issued at ₹5,000. Upon maturity, the investor receives the full ₹10,000. The difference of ₹5,000 represents the return earned over the investment period.

Key Characteristics:

• Issued at a deep discount to face value

• No regular interest payments (unlike coupon-bearing bonds)

• Lump-sum redemption at maturity

• Long-term tenure — often ranging from 5 to 25 years

• Issued by government or financial institutions

Deep Discount Bonds in India

Deep Discount Bonds in India were first introduced by Industrial Development Bank of India (IDBI) in the early 1990s, followed by ICICI Bank and other development finance institutions. These instruments allowed investors to commit a small initial investment for potentially higher returns at maturity.

IDBI’s Deep Discount Bonds, for instance, had a 25-year tenure and were issued for ₹2,700, redeemable at ₹1,00,000 on maturity — a structure that made them highly attractive for long-term investors at the time.

Although the issuance of such long-term deep discount bonds has reduced in recent years, they remain a valuable concept for understanding how time-based compounding and fixed-income structures operate.

Deep Discount Bond Formula

The current price (P) of a deep discount bond can be determined using the following present value formula:

P=F(1+r)nP = \frac{F}{(1 + r)^n}P=(1+r)nF​

Where:

P = Current price of the bond

F = Face (maturity) value

r = Discount rate or required rate of return

n = Number of years to maturity

This formula helps investors estimate whether a bond’s issue price offers a fair yield relative to other fixed-income options.

Deep Discount Bonds Are Also Called

Deep discount bonds are often referred to as zero-coupon bonds, because they do not pay periodic interest. Instead, they are redeemed at face value, with the investor’s return embedded in the price difference.

However, while all deep discount bonds are zero-coupon instruments, not all zero-coupon bonds qualify as deep discount bonds — the latter are typically issued at a significant markdown from face value, hence the name “deep.”

Tax Treatment of Deep Discount Bonds in India

Initially, deep discount bonds were taxed at maturity — treating the entire gain as capital income. However, the tax regime was later revised by the Central Board of Direct Taxes (CBDT) to ensure fair annual taxation.

Current Tax Rules (Post CBDT Circular 2/2002)

• Annual Taxation: Investors are required to mark-to-market the bond’s value each year and pay tax on accrued interest income annually, not just at maturity.

• Transfer Before Maturity: If sold before maturity, the difference between the sale price and the bond’s value at the end of the previous year is taxed as capital gains.

• Redemption: Upon maturity, the difference between redemption value and last recorded value is also treated as interest income.

This system aligns deep discount bonds with other market-linked debt instruments in terms of taxation.

Advantages & Risks of Deep Discount Bonds

• Predictable Returns – Investors know the maturity value upfront.

• No Reinvestment Risk – Since there are no periodic payouts, investors avoid the challenge of reinvesting interest.

• Suitable for Long-Term Goals – These bonds can be aligned with future needs like retirement or education funding.

• Issued by Reputed Institutions – Often backed by government or top-rated entities, providing a sense of security.

Risks and Considerations

While deep discount bonds are relatively simple instruments, investors should be aware of potential risks:

• Interest Rate Risk: Prices may fluctuate with market rates, especially for long-duration bonds.

• Liquidity Risk: These bonds may have limited secondary market liquidity.

• Tax Complexity: Annual taxation can be cumbersome for retail investors.

• Long Lock-in Periods: Funds remain tied up until maturity unless traded.

Hence, investors should evaluate their investment horizon and tax implications before participating.

Deep Discount Bonds by IDBI and ICICI: Historical Overview

IDBI Deep Discount Bonds

Issued in the 1990s, IDBI’s bonds were among the earliest examples of long-term deep discount instruments in India. They offered investors a chance to invest small amounts (₹2,700) with significant maturity value, ideal for long-term capital planning.

ICICI Deep Discount Bonds

Similarly, ICICI introduced its version of deep discount bonds, catering to retail investors looking for structured long-term investments. While these instruments are no longer actively issued, they played a foundational role in popularizing the concept of zero-coupon and deep discount bonds in India’s debt market.

Conclusion

Deep Discount Bonds in India represent a unique approach to fixed-income investing, allowing individuals to invest small amounts upfront for long-term maturity gains. While they are less common today, their structure remains relevant for understanding how bond pricing, compounding, and long-term capital appreciation work.

For investors interested in the bond market, learning about instruments like deep discount bonds helps build a deeper understanding of how various fixed-income products function — aiding more informed financial decision-making.

Frequently Asked Questions (FAQs)

1. What are Deep Discount Bonds?

These are zero-coupon bonds issued at a price significantly lower than their face value, redeemed at par on maturity.

2. Who issues Deep Discount Bonds in India?

Institutions like IDBI and ICICI historically issued deep discount bonds, though they are less common today.

3. Are Deep Discount Bonds and Zero-Coupon Bonds the same?

All deep discount bonds are zero-coupon, but not all zero-coupon bonds are “deep” — only those issued at a major discount qualify.

4. How are Deep Discount Bonds taxed in India?

Tax is levied annually on accrued interest based on the bond’s market value, as per CBDT guidelines.

5. What is the Deep Discount Bond formula?

Price = Face Value / (1 + r)^n — where r is the discount rate and n is the number of years to maturity.

6. Are Deep Discount Bonds still available?

New issuances are limited, but investors can study existing examples to understand their mechanics and use in long-term financial planning.

Disclaimer

This blog is intended solely for educational and informational purposes. The bonds and securities mentioned herein are illustrative examples and should not be construed as investment advice or personal recommendations. BondScanner, as a SEBI-registered Online Bond Platform Provider (OBPP), does not provide personalized investment advice through this content.

Readers are advised to independently evaluate investment options and seek professional guidance before making financial decisions. Investments in bonds and other securities are subject to market risks, including the possible loss of principal. Please read all offer documents and risk disclosures carefully before investing.