Joe purchased $125,000 of A and D Corporation's newly issued bonds for $114,500.The bonds carry an interest rate of 8% and mature in 5 years.What is the initial OID on these bonds?

Question

Quizplus · Accepted Answer

To calculate the initial OID, we first need to calculate the bond's par value. 
Par value = $125,000 / (1 + 0.08)^5 = $78,202. 
Joe paid $114,500, which is less than the par value, so there must be an OID. 
OID = par value - purchase price = $78,202 - $114,500 = $-36,298. 
An OID represents the difference between the purchase price and the par value. Since the OID is negative, it means the bond was sold at a premium above the par value. To calculate the initial OID, we take the absolute value of the OID and divide it by the number of years to maturity: 
Initial OID = |$-36,298| / 5 = $7,260. 
Note that the bonds carry an 8% coupon rate, but that is not relevant for calculating the OID.

Joe Purchased $125,000 of a and D Corporation's Newly Issued