Original Issue Discount (OID)

An original issue discount (OID) is the difference between a debt instrument’s face (redemption) value and the price at which it is first sold. When a bond or note is issued for less than its stated maturity value, the discount represents additional interest income that accrues to the buyer and is paid when the instrument is redeemed at par.

How OID works

• Issuer sells a bond at a price below par; investor pays the issuance price.
• Throughout the bond’s life the investor may receive coupon payments (if any).
• At maturity the issuer repays the redemption (par) price. The OID is the gain between what the investor paid and the redemption price.
• Example: Face value $100, purchase price $95 → OID = $5 (realized at maturity as interest).

Formula and calculation

OID = Redemption Price − Issuance Price

• Redemption Price: par value due at maturity.
• Issuance Price: price paid when the debt was issued.

Example: Redemption $100,000 − Issuance $90,000 = OID $10,000.

Relationship with coupon rates and interest rates

• OID size and coupon rate tend to move inversely: larger discounts often accompany lower (or no) coupon payments.
• Issuers use OID to reduce periodic interest expenses; investors accept the discount in lieu of, or in addition to, coupon income.
• Market interest-rate movements affect OID instruments like other fixed-rate bonds: rising rates generally push secondary market prices down; falling rates push them up.

Zero-coupon bonds

• Zero-coupon bonds pay no periodic interest and therefore usually trade at deep OIDs.
• Investor return comes solely from the difference between purchase price and redemption value.
• These bonds avoid issuer interest payments but can be less liquid and remain sensitive to market-rate changes.

Default risk and credit considerations

• A large OID can reflect issuer credit stress or limited investor demand.
• Bondholders rank ahead of equity in bankruptcy, but recovery of principal is not guaranteed.
• Evaluate issuer creditworthiness; the discount compensates for risk but does not eliminate it.

Advantages and disadvantages

Pros:
– Lower upfront capital required versus buying at par.
– Potential for capital gain if redeemed at full par.
– Zero-coupon OID structures simplify cash-flow expectations (single payout at maturity).

Cons:
– Large discounts may signal higher default risk.
– Total return (OID + coupons) may be lower than alternative fixed-income investments.
– OID accrues as taxable income annually, even if no cash is received until maturity.

Tax treatment

• For tax purposes, OID is treated as interest and generally taxed as ordinary income as it accrues.
• Issuers typically provide Form 1099-OID showing annual accrued OID (if $10 or more); taxpayers report that accrued amount each year.
• Short-term discount obligations that are not treated as OID at issue may be reported on Form 1099-INT when redeemed.
• Consult a tax professional or the IRS guidance for specifics, especially for complex or large holdings.

Real-world example

A company issued an unsecured note through a private placement at an original issue discount and stated the note would bear no additional periodic interest. Investors bought the note at a discount and receive the full redemption amount at maturity, realizing the OID as their return.

Quick FAQs

• How is OID calculated? Subtract the issuance price from the redemption (par) price.
• What is interest OID? The portion of the discount that represents interest income for tax purposes.
• How do I report OID? Use information on Form 1099-OID and report accrued OID as ordinary income; check guidance for short-term obligations.

Bottom line

OID is a common structure for debt issued below par—particularly zero-coupon bonds—and represents interest income that accrues over the life of the instrument. It can offer lower upfront cost and a predictable redemption gain, but it may also signal credit risk and carries annual tax implications. Evaluate total expected return, issuer credit quality, liquidity, and tax consequences before investing.