Amortization of Premium and Accretion of Discount
Chapters in this video
- 0:00 The Tale of Three Bonds and the municipal tax trap
- 1:28 Premium amortization math and the mandatory non-deductible rule
- 2:46 Early sale of a premium bond: adjusted basis only
- 4:05 OID accretion versus market discount: tax-free versus taxable
- 5:27 OID accretion math with tax-free upward adjustments
- 6:06 Price sensitivity, zero-coupon bonds, and pull to par
- 7:32 Rapid-fire exam recap
What this video covers
- Why premium amortization on tax-exempt municipal bonds is mandatory and non-deductible, and how to calculate the annual straight-line write-down
- How to compute adjusted cost basis for a premium bond sold before maturity using the amortized basis, not the original purchase price
- What original issue discount (OID) accretion is, and why the IRS treats upward basis adjustments as tax-free interest on municipal bonds
- The critical distinction between OID (tax-free, original issuance) and market discount (taxable as ordinary income, secondary market purchase)
- How to recognize market discount taxation scenarios and the investor's annual election versus deferral options for recognizing taxable income
- Why longer maturity and lower coupon increase bond price volatility, with zero-coupon bonds showing maximum price sensitivity to interest rate changes
- What pull to par means for bond price behavior as maturity approaches, and why convergence to par reduces volatility regardless of interest rate environment
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