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

An investor in a jurisdiction that taxes coupon income at 30% buys a 10-year bond at a deep discount, where the tax authority applies the original issue discount (OID) rule. Under this rule the investor is most likely to be taxed on:

Under an original issue discount rule, the investor is taxed on the discount as it is amortized over the bond's life, in addition to coupon income. The discount is treated as accruing interest each year, even though the cash is received only at maturity.

  1. Athe discount as it is amortized over the bond's life, in addition to coupon incomeCorrect
  2. Bthe discount only when the bond matures or is sold
  3. Ccoupon income only, because the discount is a capital gain

Explanation

Under OID provisions, the discount on a bond issued below par is treated as interest income that accrues over the bond's life. The investor is taxed each year on the amortized portion even though no cash is received until maturity. Deferring tax until maturity, or treating it as a capital gain, is inconsistent with the rule.

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