Accumulation Bond - Explained
What is an Accumulation Bond?
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Table of ContentsWhat is an Accumulation Bond?Tax Implications of Accumulation BondsExample of an Accumulation BondAcademics Research on Accumulation Bond
What is an Accumulation Bond?
When a bond is traded at a discount, at a price below its face value or par value, it is called a discounted bond, an accumulation bond. A bond of this nature is called an original issue discount (OID) because the price the bond is sold by its issuer is lesser than the original price or face value. Accumulation bonds are also referred to as accrual bonds. In accumulation bonds, the buyer pays less money to the issuing company but interest on bond is accumulated and paid on maturity. Since this type of bond is sold at a discount, the investor receives no interest.
Back to:INVESTMENTS & TRADING
Every bond has a face value at which it is traded, this is the market price at which it should be sold. An accumulation bond does not work as normal bonds, it is sold at a price lower than its face value. Accumulation bonds are sold at a discount and their interests are allows to accrue until they mature, that means the investor is not entitled to interest until the maturity time. Different investors, institutional investors and even government agencies whether at the local, state or federal level issue accumulation bonds.
Tax Implications of Accumulation Bonds
In accumulation bonds, bondholders do not receive coupon interest payments, rather, the interest on the bond occurs till the bond matures. For tax purposes, the accumulated interest are calculated and filed as interest income when filing tax reports with the Internal revenue service. This interest income has an impact on the tax return of the bondholder for that specific year. However, it is important to know that accumulation bonds suffer huge price declines especially when there is an increase in interest rates.
Example of an Accumulation Bond
This is an example of accumulation, this illustration will sharpen your understanding of how accumulation bonds work. If Company A is into production for equipment for producing fabrics and Company A is in need of cash to construct a facility for the equipment and also renovate offices used by its senior staff. The total amount needed by Company A is $850, 000. Company A can use sale of accumulation bond as a strategy to cater for its expenses, it sells the accumulation bond to a lender with an agreement that Company A pays no interest on the loan. If the lender agrees to this, the lender might offer Company A $1, 000, 000 but Company A would not be paid the entire amount at once, rather, it will be paid $850, 000 needed to rent a facility and renovate offices. The lenders holds back $150,000 since no payment of interest is attached.