Zero-Coupon Bond
IntermediateA zero-coupon bond is a bond that pays no regular interest. Instead, it is sold at a discount to its face value and repaid at full face value at maturity.
Most bonds pay interest, or coupons, at regular intervals. A zero-coupon bond does not. The investor's entire return comes from the difference between the lower purchase price and the face value received at maturity.
For example, a zero-coupon bond with a face value of 1,000 that matures in five years might be sold for about 822. If held to maturity, the investor receives 1,000, which works out to a return of about 4% a year.
Zero-coupon bonds are useful for investors who need a known amount at a specific future date, such as for school fees or a planned purchase, because there are no coupons to reinvest.
Their prices are very sensitive to interest rate changes, more so than coupon-paying bonds of the same maturity, because all the value comes at the end. In some tax systems, investors must pay tax each year on the implied interest even though they receive no cash until maturity. Treasury bills are a short-term example of zero-coupon securities.
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