What is Accretion Of Discount?

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Accretion of discount is the increase in the value of a discounted instrument as time passes and the maturity date looms closer. The value of the instrument will accrete (grow) at the interest rate implied by the discounted issuance price, the value at maturity, and the term to maturity.

Definition

Discount accretion refers to the increase in the value of a discount instrument over time as it approaches its maturity date. The value of this instrument increases based on the discount issue price, maturity value, and the implied interest rate over the term to maturity.

Origin

The concept of discount accretion originates from the pricing methods of debt instruments in financial markets. Over time, the value of a discount instrument gradually approaches its maturity value, reflecting the fundamental principle of the time value of money. The concept of discount accretion became widely accepted in financial markets in the early 20th century.

Categories and Features

Discount accretion is primarily applied to short-term debt instruments such as Treasury bills and commercial paper. These instruments are typically issued at a price below their face value and are redeemed at face value upon maturity. The feature of discount accretion is its implied interest rate, which reflects the market's assessment of risk and the time value of money. The advantage of discount accretion is that it provides a simple method for calculating returns, but its disadvantage is its sensitivity to interest rate changes.

Case Studies

Case Study 1: U.S. Treasury Bills. Treasury bills are a typical discount instrument, usually issued at a price below face value and redeemed at face value upon maturity. Investors earn returns through discount accretion by holding the bills to maturity. Case Study 2: Commercial Paper. Companies issue commercial paper to raise short-term funds, and these papers are typically issued at a discount. Investors earn returns by holding them to maturity.

Common Issues

Common issues investors face when applying discount accretion include sensitivity to interest rate changes and the impact of market volatility. A common misconception is that the returns from discount accretion are fixed, whereas they can actually be affected by market conditions.

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