Bond Discount in 2025: What Australian Investors Need to Know

Bonds are back in the spotlight for Australian investors as 2025 kicks off with volatile interest rates and a shifting economic outlook. If you’ve noticed news about bonds trading at a “discount,” or you’re wondering why some fixed income assets are priced below their face value, you’re not alone. Understanding what a bond discount is, how it arises, and what it means for your portfolio is essential in today’s climate.

What Is a Bond Discount?

At its core, a bond discount occurs when a bond is sold for less than its face (par) value. For example, if a government bond with a $1,000 face value is trading for $950 on the ASX, it’s at a $50 discount. This situation typically arises when prevailing market interest rates are higher than the bond’s coupon rate, making the bond less attractive unless it’s offered at a lower price.

• Face value (par value): The amount the issuer agrees to repay at maturity.
• Coupon rate: The annual interest paid to bondholders, expressed as a percentage of face value.
• Market price: The current price at which the bond is trading.

In 2025, as the Reserve Bank of Australia (RBA) holds rates above 4% to combat persistent inflation, many older bonds with lower coupons are now selling at discounts.

Why Do Bonds Trade at a Discount?

There are several key drivers behind bond discounts, and understanding them can help you spot opportunities or risks in your fixed income strategy:

1. Rising Interest Rates: When market interest rates increase, new bonds are issued with higher coupons. Existing bonds with lower coupons become less attractive, so their market prices drop below face value to compensate for the lower income stream.
2. Issuer Credit Concerns: If there are doubts about the issuer’s ability to repay (such as a corporation facing financial trouble), the bond’s price may fall below par, reflecting the added risk.
3. Market Liquidity: Sometimes, bonds are discounted simply due to low trading volume or a lack of buyers, especially in less active segments of the market.

For example, in early 2025, several state government bonds issued in 2020–2021 with coupons around 1.5%–2% are now trading at discounts, as new issues offer 4%–4.5%. Savvy investors are watching these discounts for potential capital gains if rates fall in the future.

How Does a Bond Discount Affect Your Returns?

Buying a bond at a discount can enhance your total return, but it comes with nuances:

• Yield to Maturity (YTM): This is the total return you’ll earn if you hold the bond until it matures, factoring in both coupon payments and the capital gain from buying at a discount.
• Tax Implications: In Australia, the discount may be treated as interest income or a capital gain depending on the bond type and your tax situation. The 2025 ATO guidance clarifies that capital gains from bond discounts are taxable if the bond is traded on the secondary market.
• Interest Rate Risk: If rates rise further, the bond’s price could fall more, deepening the discount. If rates fall, the bond price could move back toward par, offering capital gains.

Let’s say you purchase a $1,000 face value bond for $950. Over the next 3 years, you collect the fixed coupon payments, and at maturity, you receive $1,000. That $50 difference (minus any transaction costs and taxes) is a capital gain, boosting your overall yield compared to buying at par.

2025 Trends: Are Bond Discounts a Bargain or a Trap?

With the RBA signalling a cautious approach to rate cuts in the second half of 2025, bond discounts are still prevalent, especially in longer-dated government and investment-grade corporate bonds. Investors are weighing whether now is the right time to lock in higher yields and potential capital gains, or if further rate hikes could deepen discounts even more.

• Australian super funds are increasing allocations to discounted bonds, betting on rate stabilisation and eventual price recovery.
• Retail investors are advised to review the credit quality and duration of discounted bonds before jumping in, as higher yields often come with higher risks.
• ETFs tracking Australian fixed income have seen a surge in inflows, as they offer diversified exposure to discounted bonds and help manage individual issuer risk.

It’s a dynamic market, and 2025’s environment means discounts could present genuine value—or, in some cases, signal heightened risk.

Key Takeaways for Australian Investors

Bond discounts are a natural outcome of rising interest rates and shifting market dynamics. For investors, they offer both opportunity and risk. The key is to analyse why a bond is discounted, assess your own risk tolerance, and understand the impact on your total returns. As the fixed income landscape evolves through 2025, staying informed and agile will be crucial for making the most of bond discounts in your portfolio.