Hello,
I would like to understand what are the issues of OID (original issue discount) for the banks, investors and clients ? What is the impact of a low OID cause to the current market (95 OID of low) ?
Thank you very much
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OID is a pricing adjustment that allows to adjust the yield of a security by lower what investors pay for it.
For example, to deliver a 2% over 1 year, you can:
In practice it is used:
The other benefit for an investor is that this discount generates the same return whatever the maturity of the instrument is. So if it’s a 7 year note callable after 3 years, if it’s issued at 100 the return after 3 years is only 21 (3x7).
To deliver the same yield over 7 years by paying 5% coupon, the OID would need to be 89. If the notes are called at pr (100) the return to the investor is 100 (par) + 3x5 (coupon) - 89 (prixe paid) = 26. 5 above the case where the notes are issued at par.
So OID can be used to make the instrument more attractive
Very complete answer, thank you very much
Issuers also prefer using OID vs smacking a large coupon on their debt. The final interest they pay is the same, but it’s a marketing thing. Like putting lipstick on a pig.
Thanks for your answer. What is “eating in their flex?”
and how did you get 3x7 in your example?
Lower OID = more yield enchantment
More extreme scenario: 90 OID, 12 month maturity, and 10% rate
You’d accrete to par and earn interest within a year. Making for yield of 21-22% depending interest frequency. This would be more of a bridge financing loan and require equity like returns thus the lower OID.
Have seen some examples of more “sweetener” or 3% discount to filling X% of the book.
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