What is the accumulation of Bonds
Accumulation bond is a bond sold at a discount, known as original issue discount, and for which the Issuer is not required to make semiannual interest payments, as is usually done. In other words, the bondholder, or lender, is simply to give the company that issued the bond for less money than he legally use, and in return to abandon interest income. Accumulation bond is so named because the bond value is accumulated over time. They are also known as zero-coupon discount bonds.
Breaking down the ‘accumulation of Bonds
As accumulation bonds are always sold at original issue discount, they are always sold below face value, and the IRS considers the OID as interest. Even if the bondholder receives coupon payments, interest on the bonds is accrued and must be taken into account as interest income on the tax return of the bond each year. This is sometimes called phantom income.
Some investors like to use accumulation bonds in their financial plans as they know the exact amount they will receive at some point in the future when the bond Matures, even if they do not get interim cash flows. Investors in the accumulation of bonds should be aware, however, that the accumulation of bonds at risk a sharp decline in prices during periods of rising interest rates.
The accumulation of bonds usually issued by the Federal, local or state authorities.
Example savings Bonds
Group widget you need to build a new widget plant, and needs some extra money to renovate their offices. The plant will cost $710,000, while the repair will cost $33,000. The leaders of the group widget has decided to sell the accumulation of bonds to Finance these expenditures, promising to pay its creditors in 15 years $ 1 million. But it is an accumulation bond, the Group widget does not pay interest on the loan. Instead, he will receive only $ 1 million, but with a discount of $743,000, enough to meet their new expenses. The difference in the amount of $257,000 that the lender should not lend to compensate for the lack of interest income. In this hypothetical example, the interest rate on the bonds will be approximately 2%.
The bondholder, however, not to recognize the income all at once, either at the beginning or at the end of maturity of the bonds. That’s because the IRS treatment of this income as it accumulates over time.