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CFA Level I · CFA Level I Exam · Fixed-Income Instrument Features

A bond is issued at a substantial discount to par and pays no coupons. In many tax jurisdictions, the holder of such a bond is most likely to:

The holder is most likely taxed each year on imputed interest as the discount accretes toward par. Many jurisdictions treat original issue discount as interest income, so tax is due even though no cash coupon is received until maturity.

  1. Abe taxed on the price appreciation only when the bond is sold, never at maturity
  2. Bbe taxed each year on the imputed interest as the discount accretes toward parCorrect
  3. Cbe exempt from tax on the discount because it is a capital gain at maturity

Explanation

Many jurisdictions treat the accretion of original issue discount as interest income taxed periodically, even though no cash is received. This creates a tax liability without matching cash flow.

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