Describe an original issue discount bond – OID
A bond that is discounted from par value at a time it is issued
What are most OIDs and when would income be earned and paid
Zero coupon bonds
Earned during bonds life as Phantom Income
Paid at maturity
Does a OID/Zero Coubon bond owner have to report the phantom income each year?
Yes, even though there is nothing paid down in total maturity.
What type of investment vehicle would be best for a zero coupon/OID bond?
IRA/qualified account
Non-taxable
Wood a tax exempt OID I have to pay any taxes on the sale of the bond or gain attributed to the bond?
No, but this only refers to the original bond issue.
If a tax exempt, OID bond was purchased on the secondary market, would it still be tax exempt on the sale and any gains?
No, purchased on the secondary market could be subject to income income tax when sold
When the treasury issues, a zero coupon bond, what is it called?
STRIPS
If there is a discount on a STRIPS, what is the tax treatment?
The discount is treated as taxable income, earned annually
STRIPS produced phantom income
Why would somebody purchase an STRIPS or zero coupon OID in a tax deferred account?
Because you won’t have to pay tax on the income accrued in the tax deferred account.
In a taxable account, you would have to pay the tax even though no interest is received (phantom income)
What would be an exception to having to pay tax on a tax exempt ID bond?
If it is sold before maturity, the gain is treated as a capital gain.
In TIPS, the gain on the principal due to inflation, is it taxable?
Yes, as phantom income. And is paid during life of bond.
If a person purchases a TIPS for $1000, interest accrued of $200 in the principal increased by $300. What amount would have to be reported to the IRS when it is sold for $1400?
$100
The $200 is taxed during a life of bond and paid
The difference between $1400 and $300 is the gain or $100.
What type of an account would be best for a TIPS?
Tax deferred account, so interest doesn’t have to be paid until distribution on the appreciated amount
Are TIPS interest, subject to state and local taxes?
No
What would disqualify an EE bond being used for education purposes?
Who would it need to be owned by?
If it was owned in a UGMA/UTMA account.
The parent or adult over age 24.
What is the tax treatment in the increase in value of an EE bond? When is it paid?
Subject to ordinary income tax.
At maturity
What is the tax treatment of an Series I or EE education bond?
Tax-free if the parents AGI is less than the face out at REDEMPTION.
Are EE and I bonds marketable?
No, they are sold at face value.
Also are NON-Transferable and NON-Negotiable
What is the difference between EE/I bonds and TIPS/STRIPS in terms of payment of taxes?
EE/I Bonds - paid at maturity
TIPS/STRIPS- paid in the year accrued.
What is a similarity between an I Bond and TIPS? But what is the difference?
Both increase/decrease with inflation - NO purchasing power risk.
But I Bond doesn’t pay tax till maturity.
TIPS - paid during year accrued (unless non-taxable account)
What type of federal backed investment would be most susceptible to reinvestment risk?
Mortgage back securities (GNMA)
In a collateralized mortgage obligation – CMOs, what do the A-to-Z trenches mean?
A - Fast pay
M- Medium pay
Y - Slow pay
Z - Most Risk
The Z trach in a CMO, is similar to what type of bond? And why?
Zero coupon bond
Highest risk and highest duration.
Does a Z tranche pay interest?
No. At redemption, the collateral remaining is paid out.
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