Investing In Zero Coupon Bonds (includes calculator)

By Stock Research Pro • November 12th, 2008

Zero coupon bonds (also called zeros or discount bonds) are bonds investors purchase at a price lower than face value. The face value is paid to the investor at maturity. Zero coupon bonds do not make interest payments (coupons). Instead, investors earn the compounded which is paid at maturity along with the difference between the discounted price and its redemption (par) value.

Types of Zero Coupon Bonds

The three largest categories of these instruments are zero coupon treasury bonds (issued by the treasury), zero coupon corporate bonds (issued by corporations) and zero coupon municipal bonds (issued by state and local government entities).

Zero coupon Treasury bonds are generally considered the safest of these options as they are backed by U.S. government. Corporate and municipal zeros may offer a higher rate of return to compensate for additional credit risk. Zero coupon municipal securities are unique in that the interest they earn is free from federal income tax. In some cases, the interest may be free of state and local tax as well.

The maturity dates on zero coupon bonds are usually long-term, ten to fifteen years or longer. This can enable an investor to plan for a long-range financial goal, such as funding a college education. An investor can often put up a small amount of money (because of the deep discount) and watch the investment grow over the years to maturity.

There is a trade-off, though. Unlike regular bonds, the zero coupon bond investor doesn’t receive interest payments. Even so, they are taxed just like regular bonds. Every year the issuer sends a statement to the investor indicating how much interest accrued to the bond over the past year.

More about the difference between zero coupon bonds and regular bonds

Investors should also note that, because zeros are offered at a deep discount to their face value, they are typically subject to greater volatility than coupon bonds. As market conditions change, the market value of zero coupon bonds can fluctuate more than it might with other types of bonds. Because of this, zero coupon bonds may not be suitable for all investors.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

delicious | digg | reddit | facebook | technorati | stumbleupon | chatintamil

Leave a Comment

You must be logged in to post a comment.

« The Working Capital Ratio in Stock Analysis | Home | The Impact of Interest Rates on the Stock Market »