Legal Definitions - OID

OID stands for Original-Issue Discount.

Original-Issue Discount (OID) refers to the difference between a bond's stated redemption price at maturity and its issue price, when the issue price is less than the redemption price. Essentially, it's a debt instrument (like a bond) that is initially sold for less than its face value. This discount represents an additional form of interest income for the investor, which accrues over the life of the bond and is typically realized when the bond matures or is sold. For tax purposes, this discount is generally treated as if it were interest income that the investor receives gradually over the bond's term, even though the actual cash payment might not occur until maturity.

Here are a few examples to illustrate:

• Example 1: Zero-Coupon Corporate Bond

  Imagine a technology company issues a 10-year, $1,000 zero-coupon bond for $700. A zero-coupon bond pays no interest during its life; instead, the investor's return comes entirely from the difference between the purchase price and the face value received at maturity. In this case, the Original-Issue Discount is $300 ($1,000 face value - $700 issue price). An investor who holds this bond until maturity will receive $1,000. The $300 difference is considered interest income that accrues over the 10 years, and the investor typically pays taxes on a portion of this OID each year, even though they don't receive any cash until the bond matures.

• Example 2: Government Treasury Bill

  A government might issue a 1-year Treasury Bill with a face value of $10,000 for an issue price of $9,800. Treasury Bills are often issued at a discount and do not pay periodic interest. The Original-Issue Discount here is $200 ($10,000 face value - $9,800 issue price). An investor who buys this T-Bill will receive $10,000 at the end of one year. The $200 difference is the interest income earned, and it is considered OID. For tax purposes, this $200 is treated as interest income for the year the T-Bill matures.

• Example 3: Discounted Corporate Bond with Low Coupon

  A manufacturing company issues a 5-year bond with a face value of $5,000 and a low annual interest rate of 1%. Due to market conditions or the company's credit rating, investors demand a higher overall return. To make the bond attractive, the company issues it at a discount, selling it for $4,800. The Original-Issue Discount is $200 ($5,000 face value - $4,800 issue price). An investor holding this bond would receive the 1% annual interest payments (coupon payments) and, at maturity, the full $5,000 face value. The $200 OID is additional interest income that accrues over the five years, alongside the regular coupon payments, and is generally taxable to the investor annually as it accrues.