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Original Issue Discount Tutorial
The following is an overview of the economics and tax considerations regarding Original Issue Discount. For further reference material you may refer to IRS Publications 1212 List of Original Issue Discount Securities and IRS Publication 550 Investment Income and Expenses. Relevant tax code sections are 1271 through 1275.
  • OID Definition
  • Accrual Periods and Adjusted Issue Prices
  • The Stated Redemption Price at Maturity
  • Calculating OID
  • De Minimis OID
  • Difference Between Ratable Method & Constant Interest Method
  • Security Types
  • Accrual Calculations - Long Term OID Securities
  • History of OID securities »
  • Ratable Method versus Constant Interest (reason for a change)
  • Sample 1099-OID »
  • Fixed Rate Capital Securities
  • Secondary Market Purchases and Adjustments to OID :
  • Contingent Debt
  •  --- A Graphical Representation
     --- Applying the Income Adjustments
     --- Determining Adjusted Cost Basis
     --- Deferral of Market Discount
     --- Making the Adjustments
     
  • Inflation Protection Bonds
  • OID - a simple definition Top
    A long-term debt instrument generally has Original Issue Discount (OID) when it is issued for a price less than its stated redemption price at maturity (principal amount). The OID is the difference between the stated redemption price at maturity and the issue price. OID is considered to be a form of interest. All debt instruments that pay no interest prior to maturity (zero coupon bonds) are presumed to be issued at a discount. The majority of OID bonds are zero coupon bonds. However, it is possible for a bond making periodic coupon payments to also have OID.
     
    OID - a more technical definition
    OID = The stated redemption price at maturity - The issue price
     
    The Stated Redemption Price at Maturity
    Top
    The Stated Redemption Price at Maturity = the amount fixed by the last modification of the purchase agreement and includes interest and other amounts payable at that time. It does not, however, include "qualified stated interest."
    Qualified stated interest is any interest based on a fixed rate and payable unconditionally at fixed periodic intervals of one year or less during the entire life of the instrument. The stated redemption price at maturity is frequently Par or $1,000.00, but this is not always the case, as with Payment In Kind bonds (PIKs).
     
    De Minimis OID Top
    The IRS allows bond issuers to disregard OID (treat it as zero) if it is less than $.0025 times the stated redemption price times the number of full years from the date of original issue to maturity. A table of the de minimis cut off prices for bonds issued up to 10 years in duration follows:
    Duration Issue Price
    1 $99.75
    2 $99.50
    3 $99.25
    4 $99.00
    5 $98.75
    6 $98.50
    7 $98.25
    8 $98.00
    9 $97.75
    10 $97.50
     
    Examples
    A bond is issued on Jan 1, 1990 for $950.00. The bond matures on Jan 1, 1995, has a face value of $1,000.00 and pays interest at an annual rate of 10% on June 1st and January 1st. Redemption Price: The interest is based on a fixed rate and payable unconditionally at fixed periodic intervals. Therefore, the redemption price is $1,000.00. De minimis test: ($.0025)($1,000.00)(5 years) = $12.50. Therefore, OID for this issue is reportable if issue price is less than $987.50.
    OID = $1,000.00 - $950.00 = $50.00
    Nonqualified Stated Interest. Assume the same facts as above but the 10% coupon begins accruing on Jan 1, 1992 with the first payment on June 1, 1992. Since the bond does not make interest payments at fixed periodic intervals of less than one year the interest is nonqualified stated interest (NQSI). NQSI payments are added to the maturity value of an instrument to determine the stated redemption price. The stated redemption price therefore is $1,000.00 plus the nonqualified stated interest.
    Stated Redemption Price = $1,000.00 + 3 years * $100.00 = $1,300.00
    OID = $1,300.00 - $950.00 = $350.00
     
    Overview of Security Types
    Top
    There are currently four categories of OID securities, and for each category different information reporting and tax considerations. The nominee reports OID income on a 1099-OID. It should be noted that an investor who owns an OID security but does not receive a 1099-OID form must still report the income on his tax return. In most cases this is not equal to an investor's taxable income. A look at the different security types is shown below:
    Security type Nominee Taxpayer
    Federal Strips (CATS, TIGRs, COUGRs etc..) Calculate an approximation of income using figures published in Pub 1212. OID accrual based on the constant interest method using purchase price, purchase date, maturity value and maturity date.
    Corporate, Government, Municipals, Eurobonds, Certificates of Deposit

    Fixed maturity date

    OID accrual rates applied to the investor's holding period. Note: Nominees are not required to report municipal bond OID. Nominees reporting OID accrual on Municipal bonds are doing so as a client service. 1099-OIDs for these bonds are must be mailed by January 31st. Qualified stated interest is reported on a cash basis. OID income as reported by Nominee adjusted, at the option of the investor, for purchases with an acquisition premium or market discount. Investors that do not accrue market discount must recognize the accrued discount as ordinary income before calculating gain/loss at the time of a sale.
    Collateralized Debt Obligations, REMICs, CMOs

    Subject to accelerated repayment of principal

    OID accrual rates applied to the investor's holding period. OID rates are collected from the issuers of the bonds. OID rates are adjusted each month taking into consideration the actual prepayment experiences versus those originally projected at issuance. The 1099-OIDs must be mailed by March 15th. The 1099-OID is accompanied by an additional written statement that includes all the factors for an investor to calculate adjustments to OID income for premium, acquisition premium or market discount. Qualified stated interest is reported on an accrual basis. OID income as reported by Nominee adjusted, at the option of the investor, for purchases with an acquisition premium or market discount. The recognition of market discount may be deferred until sale or redemption (full or partial). When a principal payment is received the less of the accrued and not previously reported market discount or principal received must be reported as ordinary income.
    Short Term Obligations (Treasury Bills, and short term obligations issued by several agencies) If sold prior to maturity, report proceeds on a 1099-B and there is no 1099-INT or 1099-OID reporting. If held to maturity, report difference between cost and proceeds on a 1099-INT and there is no 1099-B reporting. If cost is unavailable, report discount as if purchased at original issue. Special rules apply to Treasury Bills and the short-term obligations of several agencies requiring the use of the discount amount for the longest maturing security on that date. The income factors are published in IRS Publication 1212. If your 1099-INT was prepared without your purchase cost, recompute the income based on your actual purchase price.
     
    Accrual Calculations - Long Term OID Securities
    Top
    There are currently 4 methods covering the apportionment of OID income over the life of a bond. They are as follows:
    Issue Dates Accrual Method Length of Accrual Period Anchor for Period Short Period
    5/29/69 to 7/1/82 Ratable Calendar Year Calendar Year  
    7/2/82 to 12/31/84 Constant Interest Annual Issue Date End of Term
    1/1/85 to 4/3/94 Constant Interest Semiannual Maturity Date Beginning of Term
    4/4/94 to Present Constant Interest Any length and vary in length over the term. Each period can not be longer than one year. All payments must fall on the first or last day of a period varies varies
     
    Ratable Method versus Constant Interest (reason for a change)
    Top
    OID accruals for long term discount securities issued between 5/29/69 and 7/1/82 are calculated using the ratable method. The ratable method simply applies a constant dollar amount for each day the security is held over the life of the security. OID securities issued after 7/1/82 are calculated by using the constant yield method. Under the constant yield method.
    OID (for an accrual period) is The Adjusted Issue Price * (The Yield to Maturity /Accrual Periods per Year)- Qualified Cash Interest Paid:
    OID = AIP * (YTM / n) - I
     
    Accrual Periods and Adjusted Issue Prices
    Top
    Long term OID securities issued between 7/1/82 and 12/31/84 have annual accrual periods beginning on the date the bond was issued and each anniversary thereafter. This will result in 2 accrual periods during the calendar year; the first starting on 1/1 and ending the day before the anniversary of the issue date and the second starting on the anniversary of the issue date and ending on 12/31. An example of this type of bond is Equitable Realty Assets Corp. (CUSIP 294548AC) issued on 6/22/84 at $200.00 per $1,000.00 of face amount and maturing on 7/1/96. The calendar accrual periods for this bond for 1990 / 1991 are as follows:
    Year Accrual Begins Accrual Ends
    1990 1/01/90 06/21/90
      6/22/90 12/31/90
    1991 1/01/91 06/21/91
      6/22/91 12/31/91
    Long Term OID securities issued after 12/31/84 have 6 month accrual periods that end on the maturity date or a date 6 months prior to that date. This will result in 3 accrual periods during the calendar year, unless the issue matures on 1/1 or 7/1 in which case there will be only 2 accrual periods during the year. An example of this type of bond is Heileman Brewing Company (CUSIP 422884AB2) issued on 8/1/85 at $250.00 per $1,000.00 of face amount and maturing on 4/3/03. The calendar accrual periods for this bond for 1990 / 1991 are as follows:
    Year Accrual Begins Accrual Ends
    1990 1/01/90 04/02/90
      4/3/90 10/02/90
      10/3/90 12/31/90
    1991 1/01/91 4/02/91
      4/3/91 10/02/91
      10/3/91 12/31/91
     
    Calculating OID
    Top
    Once the accrual periods have been established, to begin calculating OID, you need to determine the Adjusted Issue Prices (AIP). The AIP is defined as the Issue Price plus all previously accrued OID. The AIP is also commonly referred to as the accreted value:
    The AIP on the Issue Date = The Issue Price
    The AIP on the Maturity Date = The Stated Redemption Price
    Knowing the accrual periods, the issue price, the maturity value and the coupon rate, if any, gives you all the information necessary to compute the OID schedule. An example of the calculation is shown below.
    OID Accrual Calculations start with what you know and you can easily figure it out:
    Issue Date - 7/05/93
    Maturity Date - 7/10/95
    Issue Price - $700.00
    Redemption Price -  $1,000.00
      Begin Date Days AIP OID
    (Issue Date) 7/05/93 5 $700.00  
      7/10/93 184    
      1/10/94 181    
      7/10/94 184    
      1/10/95 181    
    (Maturity) 7/10/95 181 $1,000.00  
    The Yield to Maturity is calculated through a series of guesses. Guess an YTM and step through the successive calculations of AIP * YTM / n = OID (n-accrual periods per year) then the AIP for the next period = AIP from the preceding period plus the OID. When you find an YTM that gives you the stated redemption price at maturity you are done. The Yield to Maturity for the sample bond above is 18.513466%. Remember the OID for each period is the AIP * YTM. The adjusted issue price is the issue price plus all previously accrued OID.
    The OID accrual schedule is as follows:
      Begin Date Days AIP OID
    (Issue Date) 7/05/93 5 $700.00 $1.79
      7/10/93 184 $701.79 $64.96
      1/10/94 181 $766.75 $70.90
      7/10/94 184 $837.73 $77.55
      1/10/95 181 $915.28 $84.72
    (Maturity) 7/10/95   $1,000.00  
     
    Difference Between Ratable Method &
    Constant Interest Method
    Top
    Why are there so many methods? The IRS has attempted to adopt a method that will match the actual economic accrual of interest. The current regulations use the typical corporate bond that pays a semi-annual coupon based of the maturity date and the maturity date + 6 months is used as the standard model. An example of the difference between the income accrual calculated by the ratable and the constant yield methods for a sample bond is shown below.
    Issue Price - $ 700.00
    Stated Redemption Price (Maturity Value) - $1,000.00
    Duration - 3 years
    Year Ratable Accrual Constant Yield Accrual Difference Ratable Yield Constant Yield
    1 $100.00 $88.40 $11.60 14.3% 12.6%
    2 $100.00 $99.50 $0.50 12.5% 12.6%
    3 $100.00 $112.10 ($12.10) 11.1% 12.6%
    Total $300.00 $300.00      
    Under the ratable method, bondholders were required to report artificially high levels of current income in the early years of a bond's life and artificially low income on the later years.
    Comparison of Zero Coupon to Coupon Bearing Bond with equivalent yields
    Feature Coupon Bond Zero Coupon Bond
    Yield to Maturity 10% 10%
    Issue Cost $1,000.00 $1,000.00
    Redemption Value $1,000.00 $1,630.00
    Term 5 years 5 years
    Reinvestment Risk $100.00 per year to invest at the then prevailing rates. None - interest compounds at 10% semi-annually
    Volatility % Change in Value for 1% change in interest rates 3.7% 5%
    Investor profile Seeking current income lower tolerance for volatility. No need for current income - other resources to meet tax liability on accrued income - tolerance for higher volatility -used to profit from anticipated interest rate movements or to hold to maturity to fund future liability such as college tuition.
    Note: It is standard practice to issue bonds that redeem for $1,000.00 - a zero coupon bond with a redemption value of $1,000.00 and a life of 5 years and a yield of 10% would be issued at a cost of $612.50. For comparison purposes it seemed easier to compare equivalent upfront cash outlays by an investor.
     
    Income Comparison Current Coupon vs. Discount bond
    Bond Type Year 1 Year 2 Year 3 Year 4 Year 5 Total
    Coupon bond - income paid $100.00 $100.00 $100.00 $100.00 $100.00 $500.00
    Discount bond - Income accrued $102.65 $113.19 $124.81 $137.62 $151.74 $630.00
    Note: If the interest payments from the coupon bond were reinvested at a rate of 10% the final income for both bonds would be the same.
     
    Secondary Market Purchases and Adjustments to OID Top
    The amounts reported on a 1099-OID assume the instrument was purchased at the yield established by the original issue price and date. Purchases in the secondary market are often at yields, which differ from the original yield entitling the investor to make an adjustment on his tax return. These adjustments fall into three categories, market discount, acquisition premium and premium. Each is described in detail below:
     
    Income / Adjustment Component Securities issued without OID Securities issued with OID Federal Strips (A special case of OID securities)
    Interest payments Interest payments Interest payments, if the interest is qual­ified. If the interest is not qualified, inter­est payments should be treated as a return of principal N/A
    Premium adjustment Purchased above the redemption balance. Amortize the amount between the purchase price and the call price/redemption balance on a yield to call/maturity basis. Treat as an offset to interest payments. Note if the bond is convertible any premium attributable to the conversion feature may not be amortized. If not amortized currently must be taken as a capital loss at sale or redemption. For REMICs the market discount fraction supplied on the additional written statement is used to determine the adjustment. N/A
    Acquisition premium N/A Purchased above the adjusted issue price. Amortize the amount between the redemption balance and the adjusted issue price. Reduces the OID income. For REMICs the market discount fraction supplied on the additional written statement is used to determine the adjustment. N/A
    OID Income N/A Purchased at the adjusted issue price. Accrue the amount between the bond's issue price (adjusted issue price) and redemption balance based on the bond's original yield to maturity Accrue the amount between the investor's purchase price and the redemption balance based on the purchase yield to maturity. Note: If the bond is exempt from federal taxes and the purchase yield exceed the yield on the bond that was stripped the excess yield is taxable
    Market Discount Purchased below the redemption balance. Accrue the amount between the purchase price and the redemption balance. The recognition of market discount may be deferred until sale or redemption. There are 2 method of recognition, ratable or purchase yield. Market discount from tax-exempt bonds purchased after 4/30/ 93 is not exempt from federal taxes and is treated as taxable income. For REMICs the market discount fraction supplied on the additional written statement is used to determine the adjustment. De minimis test–Disregard market discount (treat it as zero) if it is less than $.0025 times the stated redemption price times the number of full years from the date of purchase to maturity. Purchased below the adjusted issue price. Accrue the amount between the purchase price and the adjusted issue price. The recognition of market discount may be deferred until sale or redemption. Market discount from tax-exempt bonds purchased after 4/30/93 is not exempt from federal taxes and is treated as taxable income. For REMICs the market discount fraction supplied on the additional written statement is used to determine the adjustment. De minimis test –Disregard market discount (treat it as zero) if it is less than $.0025 times the adjusted issue price times the number of full years from the date of purchase to maturity. N/A
    A Graphical Representation Top
    Applying the Income Adjustments Top
    Market Discount
    Additional ordinary income.
    • Accreted ratable or by custom yield
    • Taxpayer election to recognize currently or defer until sale or maturity
    Acquisition Premium
    Reduction of OID income.
    • Amortized using fixed fraction method
    Bond Premium
    Offset to all OID income.
    • Reduction of interest income
    • Custom yield calculation needed
    • Taxpayer election to offset interest, must amortize tax-exempt issues prior to gain/loss determination.
    Determining Adjusted Cost Basis Top
    The adjusted cost basis for the purpose of determining realized gains and losses is determined as follows:
    Original Cost
    + OID Accrued to Date
    -  Acquisition Premium to Date
    -  Premium Amortization to Date
    + Applicable Market Discount to Date
    -  Principal Repaid to Date
     
    Deferral of Market Discount Top
    If market discount is deferred, it must be recognized as ordinary income prior to the determination of gain and loss at the time of maturity or sale to the extent it is realized. For example, if an investor purchased a bond at 90% of its face value with 10 full years to maturity, market discount would accrue at 1%/year. If the investor chose to defer market discount and sold the bond after 5 years, there would be 5% of the redemption value of accrued but unrealized market discount. If the bond was sold for 90% there would be no market discount income recognized. If the bond were sold for 92.5% of face, there would be market discount income of 2.5% and no gain or loss. If the bond were sold for 97% of face, there would be market discount of 5% and a capital gain of 2%.
     
    Making the Adjustments Top
    Income that is reported on a 1099-OID should be listed on a tax return as the IRS matching program compares tax returns to 1099s. Adjustment to reported income should be listed as a separate line item. See the example below:

     
    Fixed Rate Capital Securities Top
    Structure
    Fixed rate capital securities remain one of the most talked about tax reporting issues. Clients question the origin of OID, ask how the days are counted and wonder what to do with interest payments. The issuance of these securities has not slowed, although most of the new issues do not have OID income due to changes in IRS regulations.

    Considered a creative way of securing long term financing for corporations, the introduction of MIP's (Monthly Income Preferred Securities) in October 1993 spawned imitations and offspring. MIDs, QUIDs, QUICs, TOPrS and others soon followed, each with special information reporting needs that make life continually challenging for tax reporting professionals. In addition, contingent payment debt regulations hold a provision upon which many of the newer issues rely. Called the "remote contingency," the provision states that for purposes of determining OID, an issuer may ignore any contingency that it considers unlikely to occur.

    MIPs are partnerships, basically MLPs masquerading as a preferred stock. Processing MIPs initially required correct coding of the security master file to bring the new issues into the existing MLP reporting stream. The succeeding generations of new fixed rate capital securities, however, are more challenging. Nearly all fixed rate capital securities issued prior to August 13, 1996 are reportable on form 1099-OID. Those issued since that date require varied approaches to tax reporting

    Features
    The newest preferred issues, which take the form of directly issued debt or of debt issued by a trust (which is controlled by the parent corporation), have a number of common features.
    • Exchange listed
    • Denominated as "shares"
    • Deferrable interest payments
    • Callable
    • Maturity sometimes extendable
    • Trades flat (without accrued interest calculation)
    • No voting rights
    • Subordinated to other debt
    • Senior to all stock
    • Can be issued with OID
    Issuer Concerns
    The Issuer of these securities is motivated primarily by the opportunity to obtain long term, tax deductible financing which is treated as equity for credit rating purposes. Because the debt is so deeply subordinated, ratings agencies consider it to be equity and, therefore, not a drag on the credit rating. Furthermore, payments made by the company are considered interest and can be claimed as a business expense, something that cannot be done for dividend payments.
    Investor Concerns
    These securities attract investors who are interested in investment grade, income-producing instruments. However, a corporate investor should be aware that the periodic distributions are not dividends and, therefore are not eligible for the dividends received deduction on the corporate income tax return. An investor should also realize that the issue can be called (reinvestment risk) and in some cases the maturity extended. Most importantly, all investors must be aware that the issuer may suspend interest payments for up to 5 years. While such an action is usually considered remote and can take place only after the suspension of dividends on the common shares, it results in double jeopardy. First, the investor does not receive periodic income. Second, because it is an OID instrument, the accrual of income must still be recognized even though it is not currently being received. Even the instruments reporting current income on a 1099-INT will be subject to OID reporting once an interest payment is deferred.
    Tax Reporting Concerns Characterizing Distributions
    Periodic distributions made on these issues are interest, not dividends, a distinction that is important for several reasons. The applicable withholding on portfolio interest for properly documented Non Resident Aliens would be zero. Treating these distributions, as dividends would invoke withholding where none is appropriate. Also, corporate holders must be made aware that the distributions are not eligible for the dividends received deduction.

    At this point, many wonder: Is the interest qualified? The answer to this question is a resounding - maybe. As bewildering as this sounds to investors, what appear to be dividends is actually interest, which may be qualified or non-qualified. Here's why:

    • Interest Payments
      For interest to be Qualified Stated Interest (QSI), it must be payable unconditionally, payments must be made at least annually for the entire life of the bond, and the interest rate must be a fixed rate or a good variable rate (tied to a qualified index). Prior to August 13, 1996, the ability of the issuer to defer interest payments made these distributions non-QSI. As such, the interest was included in the redemption value of the instrument. For example, the redemption value of a five-year obligation with a 10% coupon is $1500 ($1000 principal plus ten semi - annual $50 coupon payments). If the issue price of the bond was 100% ($1000), it has $500 of OID (Redemption Price - Issue Price) to be recognized over its life. These securities, and all others with non-qualified interest, will bear the appropriate NQSI Indicator on the Holding Period Specific output files. Additionally, this publication has a separate section dedicated to issues with non-qualified interest.

      Instruments issued on August 13, 1996 or later may treat interest payments on these obligations as QSI if the likelihood of deferring any interest payment is deemed remote. Most Fixed Rate Capital Securities issued after this date take this approach. For these obligations, the interest payments are reportable on a 1099-INT form. It is important to remember that as soon as an interest payment is deferred, the bond is treated as reissued on that date, the interest becomes non-QSI, and income will be reportable on an accrual basis (1099-OID) for the remaining life of the security. This remains true even if the security resumes regular interest payments.

    • Coordinating 1099-INT and 1099-OID Information Returns
      In cases where the cash interest payment is considered non-QSI, it is treated as a return of principal because it is part of the redemption balance. All income is recognized in the accrual of OID. This characterization necessitates the coordination of 1099-INT and 1099-OID reporting. In short: distributions on bonds that are paying non-QSI should not be reported on a 1099-INT.
    Contingent Debt Top
    Structure
    On June 14, 1996 the IRS published final regulations in the Federal Register on handling contingent payment debt instruments. These regulations apply to instruments issued on or after August 13, 1996, and they have an impact on Original Issue Discount information reporting. Knowing what types of instruments are affected by these regulations and how it will change your tax reporting will make answering questions on these instruments much easier.

    The contingent payment depends on the change in value of a market index, linked equity or on the occurrence (or non-occurrence) of a specific event. Contingent debt instruments must have one or more of these types of payments. If the issuer considers the likelihood of a contingency remote, the issuer may ignore the contingency when determining if the instrument is issued with OID.

    Using the non-contingent bond method, the issuer of a contingent obligation determines OID by first setting a comparable yield for the instrument, including the contingent payment. A payment schedule is then created to reflect the comparable yield. Because the contingent payments are usually made at maturity, you will often see the adjusted issue price going to a value above par.

    Contingent debt instruments issued to date are mainly Certificates of Deposit (CD's), market indexed notes and stock linked notes. These instruments are issued at or close to par value, and usually have one contingent payment at maturity. Often the payment due at maturity is linked to a market index like the S&P 500 or the Nikkei 225, but it is becoming common for the contingent payment to be based on the change in value of a single stock.

    Convertible contingent obligations have the possibility of a contingent payment as some point in the future therefore they fall under the contingent debt regulations, requiring them to accrue income at a comparable yield. These bonds traditionally issued at very low yields will now be accruing income at a much higher rate and may raise questions with investors.

    Investor Concerns
    The holder of a contingent payment debt instrument is required to recognize OID income based on the comparable yield provided by the issuer regardless of the performance of the index or stock to which the instrument is linked. On the maturity date the investor must compare his adjusted basis to the final payment and make the necessary adjustments to income.
    Tax Reporting Concerns
    The majority of contingent payment debt instruments that have been issued have only one contingent payment that is due at maturity. At maturity these issues pay a redemption amount plus the contingent payment. It is important to note that the contingent payment has already been recognized as income in the form of OID over the life of the bond. If the contingent payment is les than the projected payment the investor can take an ordinary loss up to the amount of previously included income. Beyond that amount the loss is considered capital. If the contingent payment exceeds the projected payment the gain is ordinary income.
     
    Inflation Protection Bonds Top
    Structure
    Issued with a constant par value and usually in increments of $1000, these bonds are designed to protect an investor's capital against inflation, thereby, maintaining purchasing power. The principal value fluctuates daily along with changes in the CPI-U (Consumer Price Index – Urban). The bonds also pay interest semi-annually, by applying a fixed interest rate to the principal balance of the bond, not the par value.

    The bonds will make a final payment based on the CPI-U for the maturity date. Investors, however, are guaranteed a minimum of par value at the time of maturity. Inflation indexed bonds may be stripped into principal and interest components. These are not inter-changeable like other U.S. Treasury STRIPS. An interest strip may mature for less than the par value (during periods of deflation), while the corpus strip guarantees that you will receive at least par value at maturity. There have been no inflation-indexed bonds that have been stripped and sold to investors to our knowledge.

    Features
    Inflation indexed bonds have a number of common features.
    • Par Value remains constant
    • Principal Balance varies daily
    • Interest rate is fixed
    • Coupon Payments vary with the principal balance
    • Bonds may be stripped
    • CPI-U index is applied with a 3 month lag
    Tax Reporting Concerns
    • Calculating OID
      Two methods have been developed to calculate OID for inflation protection obligations: the "Coupon Bond Method" and the "Discount Bond Method". The coupon bond method is a point-to-point calculation, and is used for obligations issued at par or with de minimis discount. The discount bond method is a complex variation on the traditional semi-annual compounding method. It is the method used for the stripped components of inflation bonds or obligations issued with more than a de minimis amount of discount.
    • Coupon Bond Method to determine OID
      The principal balance on a specific date is calculated using the following formula:
    (Par Value) X (CPI@Period End - CPI@Period Begin)
    CPI@Issue
    Top
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