Accrued Market Discount 

Bond investments are an integral part of a balanced portfolio, particularly for investors seeking predictable income or lower-risk exposure compared to equities. However, to maximise the benefits of fixed-income securities, investors must grasp certain essential financial concepts, such as accrued market discount (AMD). This article explains AMD, ideal for beginner investors aiming to enhance their understanding of how bonds work, how AMD is calculated, how it impacts taxes, and how it can be managed effectively. 

What Is Accrued Market Discount? 

Accrued market discount (AMD) refers to the appreciation in value of a bond purchased on the secondary market at a price below its face value (par). This occurs when the bond’s price increases steadily as it approaches maturity, due to the difference between the purchase price and its par value. 

For example, suppose a bond has a face value of US$1,000 but is purchased in the market for US$950. The US$50 difference is the market discount. Over time, as the bond nears maturity, this discount is considered to “accrue”, and by the time the bond matures, the investor receives the full face value. The US$50 gain is the accrued market discount. 

AMD is important because, under US tax rules, this discount is treated as ordinary income, which can have implications on how much tax an investor owes. 

Understanding Accrued Market Discount 

To properly understand AMD, one must first recognise how bonds are traded in secondary markets. A bond can trade at: 

• Par: Equal to its face value. 

• Premium: Above its face value. 

• Discount: Below its face value.

When an investor purchases a bond at a discount on the secondary market, either due to rising interest rates, a reduced credit rating of the issuer, or market demand, the discount begins to accrue. AMD applies specifically to these discount bonds. The discount starts to “accumulate” as the bond moves closer to its redemption date. 

Key Characteristics of AMD: 

• Applies to Secondary Market Purchases: AMD occurs when investors purchase bonds that are already in circulation, rather than directly from the issuer. 

• Is Taxable: The accrued discount is generally treated as taxable interest income under IRS guidelines. 

• Excludes De Minimis Rule Cases: Bonds purchased with minimal discount (less than 0.25% of par value multiplied by the remaining years to maturity) may not be subject to AMD rules under the US de minimis rule. 

AMD can also apply to Singapore Government Securities (SGS) bought below par, though local tax rules may vary. As of 2025, Singapore does not tax capital gains; however, interest income may be taxable depending on the investor’s residency and the type of bond. 

How Does Accrued Market Discount Work? 

AMD functions on the principle of time-based value recovery. As a discounted bond nears its maturity, its price incrementally increases to approach par value. This increase is recognised as a gain and is taxable in jurisdictions like the US. 

Basic Example: 

An investor purchases a five-year US Treasury bond with a face value of US$1,000 for US$950. 

• Market Discount = US$1,000 – US$950 = US$50

• This US$50 does not appear all at once but is accrued over the bond’s remaining life.

Under IRS rules, this accrued amount must be recognised as ordinary income, either gradually (annually) or when the bond is sold or matures. 

Tax Implications: 

1. Deferred Recognition: AMD is reported upon sale or redemption. 
2. Annual Accrual: Investors may elect to include the AMD in income each year, which increases the bond’s cost basis and smoothens tax liability. 

In Singapore, since capital gains are not taxed for individuals, AMD may not create a tax burden, unless the bond is structured in a way that categorises the income as interest. 

Strategies for Managing Bonds with Accrued Market Discount 

1. Holding Until Maturity

Investors who hold the bond until it matures will receive the full face value and must account for the AMD at that time. This method delays tax payments, which could be beneficial for short-term cash flow. 

• Pros: Simpler tax accounting; aligns gain with cash receipt. 

• Cons: May result in a significant one-time tax liability. 

2. Electing Annual Accrual

Under the IRS guidelines, investors may choose to report the AMD annually using the constant yield method. This election is irrevocable for the life of the bond. 

• Pros: Reduces the tax impact at maturity or sale. 

• Cons: Requires accurate tracking and annual reporting. 

3. Using Tax-Advantaged Accounts

Placing discount bonds in retirement accounts (such as IRAs in the US or the Supplementary Retirement Scheme in Singapore) can defer or eliminate taxes on AMD. 

• Pros: AMD does not trigger immediate tax. 

• Cons: Limitations on withdrawals and contribution caps. 

How to Calculate Accrued Market Discount on Bonds 

There are two commonly used methods for calculating AMD: 

1. Straight-Line Method

This approach divides the total discount equally over the bond’s remaining life. 

Formula: 

AMD = Par Value – Purchase Price/Years to Maturity 

Example: 

• Bond Par: US$1,000 

• Purchase Price: US$950 

• Term Remaining: 5 years

  AMD/year = 1000 – 950*5 = US$10 

2. Constant Yield Method (IRS Preferred)

This method uses the bond’s yield to maturity (YTM) to determine a compounding AMD. 

Formula: 

AMD*t = (Adjusted Basis t-1/YTM) – Coupon 

Example: 

• Purchase Price: US$950 

• YTM: 5% 

• Annual Coupon: US$30 

• Year 1 AMD = (950* 0.05) – 30 = 17.50
   

Each year, the adjusted basis increases by the previously accrued AMD, meaning each year’s AMD is slightly larger than the last. 

Frequently Asked Questions