Business, Legal & Accounting Glossary
A bond which pays no coupons, is sold at a deep discount to its face value, and matures at its face value. A zero-coupon bond has the important advantage of being free of reinvestment risk, though the downside is that there is no opportunity to enjoy the effects of a rise in market interest rates. Also, such bonds tend to be very sensitive to changes in interest rates, since there are no coupon payments to reduce the impact of interest rate changes. In addition, markets for zero-coupon bonds are relatively illiquid. Under U.S. tax law, the imputed interest on a zero-coupon bond is taxable as it accrues, even though there is no cash flow.
With a Zero Coupon Bond, the holder of the bond gets a lump sum upon maturity instead of periodic payments of interest during the lifetime of the bond. When the bond is issued, it costs significantly less to purchase than what it will pay upon maturity.
A zero-coupon bond is a debt instrument that pays no interest. Instead, its price is deeply discounted when issued, but at maturity, the bond is refunded at the full face value. Hence, the bond pays accumulated interest in a single lump-sum payment at maturity. The bond is so named because the coupon rate (the amount of interest paid) is zero. Rather than paying interest on a periodic basis, these bonds are issued at a fraction of their par value and increase in value as they approach maturity (e.g., U.S. savings bonds). Also known as an accrual bond. Also called zeros.
Some prefer zero-coupon bonds because the interest is effectively reinvested and compounded in the single instrument with minimal hassles. However, when held in a taxable account, one is supposed to pay income tax on the calculated interest annually, even though you do not receive the interest in cash.
Bond
A zero coupon bond is one that does not have a stated interest rate. In order to earn an effective interest rate, investors purchase these bonds at a significant discount to their face value. A US savings bond is an example of a zero coupon bond.
Because payments are delayed until maturity, the price of a zero coupon bond is more likely to fluctuate over time to reflect changes in interest rates. This increases the risk of investors not receiving the expected returns.
A zero coupon convertible bond allows investors to convert to stock if the stock price reaches a level higher than its current price on the open market.
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This glossary post was last updated: 13th April, 2022 | 0 Views.