investors, by comparison, received a
discount bond reflecting a 66.3%
Market
discount bonds, similar to those acquired at par or premium, may, nonetheless, increase in value and call risk because of factors other than a change in interest rates, such as an increase in the bond's rating or an overall increased demand for a newly popular sector of corporate bonds.
Are interest expenses deductible if market
discount bonds are purchased or carried with borrowed funds?
Announced in March 1989, the Brady plan contemplated the commercial banks' exchange of sovereign debt for bonds, either par or
discount bonds, collateralized by a special issue of U.S.
n-period nominal
discount bonds; if issued in period t, they pay off a dollar with certainty in period t + n.
However, there is a limit on the deductibility of interest expense on debt incurred to purchase or carry market
discount bonds. Such interest expense can be deducted to the extent there is interest income on the bond (including original issue discount) that is includable in income.
For a
discount bond, the basis increases at the rate of the accrued market discount until it reaches the principal value at maturity.
In one case,
discount bonds worth over 100 million yen were concealed in zabuton cushions in the home of a relative of the tax evader.
Explicit interest expenses are the real capital gains on one-period
discount bonds; implicit interest expenses are the capital gains to the public from holding longer term bonds.
Because the definition of cash flow is quite general, it can be used for general insurance as well as combinations of whole life insurance, term life insurance, deferred life insurance, annuities, and pure
discount bonds.
Building on the rational option pricing theories of Black and Scholes (1973) and Merton (1973) suggesting that the option pricing model can be used to price elements of corporate capital structure, Merton (1974) presents the systematic development of a theory for pricing
discount bonds when there is a significant probability of default at maturity.
Since many of the holders of PIK or deep
discount bonds are tax-exempt pension trust or foreign holders, however, no one is likely to complain about the lack of symmetry in view of the fact that the OID accrual otherwise is a tax-neutral event.
