Accrued Market Discount refers to the decline in the market value of a debt instrument, such as a bond or note, occurring from the time it was issued until the present. It is the amount by which the purchase price of the instrument exceeds its adjusted cost basis.
When an investor purchases a debt instrument at a price lower than its face value, a discount is realized. The accrued market discount is the additional discount that accumulates over time as the market value of the instrument adjusts to its face value or redemption price. This adjustment usually occurs at a predetermined rate, such as the instrument’s yield or a fixed interest rate. The accrued market discount is calculated by subtracting the purchase price of the instrument from its adjusted cost basis.
Accrued market discount arises when a debt instrument is bought after its issuance date, and the purchase price is below the face value or redemption price that the issuer will pay on maturity. The discount represents the difference between the face value and the purchase price. As time progresses, the market value of the instrument tends to increase, approaching its face value. This means that the investor can potentially earn income from the accrued market discount.
For tax purposes, accrued market discount is treated as taxable income by the Internal Revenue Service (IRS). The amount of the discount must be included in the investor’s annual tax return as interest income. The IRS uses various methods to determine the accrued market discount, such as the constant yield method or the ratable accrual method, depending on the instrument and its specific features.
Accrued market discount is commonly associated with fixed-income securities, such as bonds, where the discount is accounted for over the life of the security. However, it can also apply to other types of debt instruments, including short-term notes, Treasury bills, and commercial paper. The accrued market discount is a critical factor for investors to consider when buying or selling debt instruments because it affects the overall return on investment.
It is important to note that accrued market discount should not be confused with market discount. While accrued market discount represents the accumulation of discount over time, market discount is the reduction in the market price of a debt instrument compared to its original sale price. Market discount is often realized when an instrument is purchased on the secondary market at a price lower than its face value.
In conclusion, accrued market discount refers to the gradual appreciation of a debt instrument’s value over time, as it moves closer to its face value. This increase in market value can lead to taxable income for investors, which must be reported to the IRS. Understanding how accrued market discount impacts the return on investment is crucial for individuals and entities involved in finance, billing, accounting, corporate finance, business finance, bookkeeping, and invoicing.
This glossary is made for freelancers and owners of small businesses. If you are looking for exact definitions you can find them in accounting textbooks.