The term “accrual of discount” refers to the yearly gain or annual addition to the value of a bond. Note that this gain, also known as “book value”, comes about specifically due to the bond having been initially purchased for an amount that calculates out to less than its nominal value.
This is also referred to as a purchase “below par,” where the par value is referring to the face value of the bond, the current rate of interest, the date of maturity, and the amount of interest that is to be paid on a semi-annual basis.
You see, whenever an investor purchases a bond at a discount, he or she receives a return from two specific sources. The first source is the interest income that is received every six months. The second source is the financial gain that is received at the time when that bond reaches maturity.
The nice thing about this accrual of discount is that it is added to the interest income that you already receive semi-annually. The discount is accrued, also described as “accreted”, over the entire life of the bond, and must be calculated both for tax and for portfolio purposes.
There are two methods for calculating the accrual of discount. One is the straight-line method, which accrues in equal installments over the life of the bond. The other is the scientific or yield basis method, which is required for most income tax reporting.
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