Definition
Original Issue Discount (OID) is a type of discount from the par value, or face value, of a bond at the time it is issued. Essentially, it represents the difference between a bond’s face value and its selling price when initially issued. The most extreme version of an OID is exhibited in zero-coupon bonds, which are sold substantially below their par values and do not pay interest until they mature.
The tax treatment of OID bonds is detailed and must be carefully managed, as the OID needs to be amortized over the bond’s life. This process incrementally increases the basis of the bond over time.
Examples
- Zero-Coupon Bond: A bond with a face value of $1,000 issued at $600. The $400 discount is the OID, fully realized at maturity.
- Corporate Bonds: A company issues a $10,000 bond at $9,500. The initial $500 difference is treated as OID.
- Municipal Bonds: A city issues a $5,000 bond at $4,800. The $200 difference is the OID.
Frequently Asked Questions (FAQs)
What is Original Issue Discount (OID)?
OID refers to the discount from the bond’s par value when it is initially issued. This discount represents the interest to be received at maturity.
How is OID taxed?
OID is treated as interest for tax purposes and must be included in the investor’s taxable income over the bond’s life through amortization.
What is an example of an extreme Original Issue Discount (OID)?
Zero-coupon bonds are the most extreme example, often sold at significant discounts and paying no interest until maturity.
Why is the basis of a bond important in the context of OID?
The basis of a bond reflects its adjusted cost, which affects capital gains or losses upon sale or maturity. OID amortization increases the bond’s basis over time.
Can all bonds have an OID?
Not all bonds have an OID. It primarily occurs in bonds issued at a discount to their face value.
Related Terms
- Par Value: The face value of a bond, which is the amount the issuer agrees to pay back at maturity.
- Zero-Coupon Bond: A bond that does not pay periodic interest and is sold significantly below face value, with interest realized upon maturity.
- Amortization: The process of gradually writing off the initial cost of an asset over time.
- Basis: The bond’s adjusted purchase price used for calculating capital gains or losses.
Online Resources
- Investopedia on Original Issue Discount (OID)
- IRS Publication 1212: Guide to Original Issue Discount (OID) Instruments
- Securities and Exchange Commission (SEC) on Zero-Coupon Bonds
Suggested Books for Further Studies
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman, Angel Serrat.
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau.
- “Fixed Income Analysis” by Barbara S. Petitt, Jerald E. Pinto.
Fundamentals of Original Issue Discount (OID): Finance Basics Quiz
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