Definitions

The following terms are used throughout this publication. "Original issue discount" is defined first. The other terms are listed alphabetically.

Original issue discount (OID). OID is a form of interest. It is the excess of a debt instrument's stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID.

Accrual period. An accrual period is an interval of time used to measure OID. The length of an accrual period can be 6 months, a year, or some other period, depending on when the debt instrument was issued.

Acquisition premium. Acquisition premium is the excess of a bond's adjusted basis immediately after purchase, including purchase at original issue, over the bond's adjusted issue price at that time. A bond does not have acquisition premium, however, if the bond was purchased at a premium. See Premium, later.

Adjusted issue price. The adjusted issue price of a debt instrument at the beginning of an accrual period is used to figure the OID allocable to that period. In general, the adjusted issue price at the beginning of the instrument's first accrual period is its issue price. The adjusted issue price at the beginning of any subsequent accrual period is the sum of the issue price and all the OID includible in income before that accrual period minus any payment previously made on the instrument, other than a payment of qualified stated interest.

Debt instrument. The term "debt instrument" means a bond, debenture, note, certificate, or other evidence of indebtedness. It generally does not include an annuity contract.

Issue price. For instruments listed in Section I-A and Section I-B, the issue price is the initial offering price to the public (excluding bond houses and brokers) at which a substantial amount of these instruments was sold.

Market discount. Market discount arises when a debt instrument purchased in the secondary market has decreased in value since its issue date, generally because of an increase in interest rates. An OID bond has market discount if your adjusted basis in the bond immediately after you acquired it (usually its purchase price) was less than the bond's issue price plus the total OID that accrued before you acquired it. The market discount is the difference between the issue price plus accrued OID and your adjusted basis.

Premium. A debt instrument is purchased at a premium if its adjusted basis immediately after purchase is greater than the total of all amounts payable on the instrument after the purchase date, other than qualified stated interest. The premium is the excess of the adjusted basis over the payable amounts. See Publication 550 for information on the tax treatment of bond premium.

Qualified stated interest. In general, qualified stated interest is stated interest that is unconditionally payable in cash or property (other than debt instruments of the issuer) at least annually over the term of the instrument at a single fixed rate.

Stated redemption price at maturity. An instrument's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on the instrument other than qualified stated interest.

Yield to maturity (YTM). In general, the YTM is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the issue price of the bond. The YTM is generally shown on the face of the bond or in the literature you receive from your broker. If you do not have this information, consult your broker, tax advisor, or the issuer.

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