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Deep Discount Bond (DDB)

A deep discount bond is a form of ZIB. It is issued at a deep/steep discount over its face value. It implies that the interest (coupon) rate is far less than the yield to maturity. The DDB appreciates to its face value over the maturity period.

The DDBs are being issued by the public financial institutions in India, namely, IDBI. SIDBI and so on. For instance, IBDI sold in 1992 a DDB of face value of Rs 1 lakh at a deep discount price with a maturity period of 25 years. If the investor could hold the DDB for 25 years. the rate of return would work out to 15.54 per cent. The investor had the option to (put option) at the end of every five years with a specified maturity/deemed face value ranging between Rs 5.700 (after 5 years) and Rs 50.000 (after 20 years) the implicit annual rate of being 16.12 and 15,71 per cent respectively. The investors could also sell the DDBs in the IBDI had also the option to redeem them (call option) at the end of every 5 years to take advantage of prevailing interest rates. A second series of DDBs was issued by 1996 with a face value of Rs 2 lakh and a maturity period of 25 years, the deep price being Rs 5,300.

The merit of DDBs/ZIDs is that they enable the issuing companies to conserve cash during their protect the investors against the reinvestment risk to the extent the implicit interest is automatically reinvested at a rate equal to its yield to maturity. However, they are requested to high repayment risk as they entail a balloon payment on maturity.

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