Legal Definitions - original-issue discount

Original-Issue Discount (OID) refers to the difference that occurs when a debt instrument, such as a bond, is initially sold to investors for a price lower than its face value (also known as par value or maturity value).

Essentially, OID represents the additional return an investor receives at maturity beyond the initial purchase price, serving as a form of interest earned over the life of the debt instrument. This discount is built into the security's structure from the moment it is first issued.

Here are some examples to illustrate Original-Issue Discount:

• Corporate Bond Issuance: Imagine a technology company needs to raise capital and decides to issue bonds. Each bond has a face value of $1,000, meaning the company promises to pay back $1,000 to the bondholder at maturity. However, due to prevailing market interest rates or the company's credit rating, they might initially sell these bonds to investors for $970 each. The Original-Issue Discount (OID) in this scenario is $30 ($1,000 face value - $970 initial sale price). An investor who buys this bond pays $970 upfront but receives $1,000 when the bond matures, effectively earning $30 through the discount.

• Zero-Coupon Bonds: A common example of OID is a zero-coupon bond, which does not pay periodic interest payments. Instead, it is sold at a deep discount to its face value, and the investor's entire return comes from receiving the full face value at maturity. For instance, a government might issue a zero-coupon bond with a face value of $10,000 that matures in 10 years. This bond could be initially sold for $7,500. The Original-Issue Discount (OID) here is $2,500 ($10,000 face value - $7,500 initial sale price). The investor pays $7,500 today and receives $10,000 a decade later, with the $2,500 difference being the OID.

• Treasury Bills (T-Bills): Short-term government debt instruments, like U.S. Treasury Bills, are typically issued with an OID. A T-Bill might have a face value of $5,000 and a maturity of 90 days. If it is initially sold at auction for $4,980, the Original-Issue Discount (OID) is $20 ($5,000 face value - $4,980 initial sale price). The investor pays $4,980 and receives the full $5,000 after 90 days, with the $20 discount representing the interest earned over that short period.