Business, Legal & Accounting Glossary
A discounted bond that is traded and pays no coupon interest during its life. Instead, both the Principal and the Interest are paid at the maturity date.
A Zero-coupon bond is a bond issued at a discount to mature at its face value; the discount is set so that no interest is paid within the life of the bond.
In essence, it is a type of bond that offers no-interest payments.
In effect, the interest is paid at maturity in the redemption value of the bond.
A bond that (1) pays no interest but is sold subpar, (2) interest-paying bond stripped of its coupon.
Also known as a non-interest bearing bond, zero-interest bond, zero-rated bond.
A bond without a stated interest rate.
Because no interest is paid, the bond will sell for a discount from its maturity value.
Rather than receiving interest, an investor’s compensation will be the difference between the discounted price at which the bond was purchased and the price the investor receives when selling the bond. As such, the difference between the par value and discount value generates profit.
If the investor holds the bond to maturity, the investor will earn the difference between it’s discounted cost and it’s maturity value.
One advantage of issuing a zero-coupon bond is that the issuer does not need to make periodic interest payments to its bondholders. Investors sometimes prefer zero-coupon bonds as they may allow for more favourable tax treatment. One possible disadvantage to bond investors is that zero-coupon bond prices are more volatile on the secondary bond market since the lack of periodic interest payments is viewed as risky. A zero-coupon bond is also known as an accrual bond.
In the fixed income markets, there are a variety of instruments that defer the payment of interest.
Generally, the instruments are called deferred-interest bonds (DIBs). They fall into three categories.
The instruments generally have terms of ten years or more. If they are issued with shorter terms, they may be called notes instead of bonds.
While accrued-coupon and zero-coupon bonds only pay interest at maturity, for accounting and tax purposes, interest is generally recognized as income when it accrues. Treatment of deferred-coupon bonds depends upon the specific structure and jurisdiction.
Paradoxically, you will hear of accrued-coupon and zero-coupon bonds being described as either safe, conservative investments or risky, speculative investments. It all depends on how you intend to use and account for them. For a buy-and-hold investor who accounts for them at book value, the bonds can be a safe investment, so long as the issuer is of good credit quality. They guarantee a specific yield until maturity. Because they don’t pay coupons, they pose no reinvestment risk. On the other hand, for investors who may sell the bonds prior to maturity or account for them at market value, they can be quite risky. Their duration equals their time to maturity. Many of these bonds have terms of 20 or 30 years. With durations like that, their market values can be as volatile as those of common stocks. Examples of these types of bonds are municipal accrued-coupon bonds and Treasury zero-coupon bonds.
Deferred-coupon bonds usually have considerable credit risk. This is because they tend to be issued by corporations that lack the cash flow to meet near-term coupon payments. Usually, they are junk bonds.
Two variants of deferred-coupon bonds are
Securitizations are often structured with tranches that defer interest. In the context of collateralized mortgage obligations, these are called Z bonds.
Zero coupon bonds are sold at, significant discounts from par but pay no current interest.
It is, in a sense, a perpetual zero-coupon bond. A bond without a stated interest rate.
Gold generates no income. It is, in a sense, a perpetual zero-coupon bond – except it has no fixed maturity period.
There are 2 methods for deduction of the zero-coupon bond yield curve: the direct method and the indirect method.
zero coupon, zero-coupon, zero bonds
A Zero Coupon Bond is a debt security that is sold at a discount and does not pay any interest payments to the bondholder. In other words, it’s a bond that sells for less than its face value and does not make coupon payments or periodic interest payments during its life. At maturity, it can then be redeemed at its face value allowing the bondholder to make a profit.
Companies, schools, and governments use bonds as a way to finance expansions and other long term projects. Usually, the decision to issue a bond starts with a proposal for new projects. When the board or governing body approves the plans, a bond can be issued. Unfortunately, it isn’t that easy. Sometimes it can take a few months for the bond to be drafted and actually issued to the public. This presents a problem. The interest rate and terms of the bond are set when the bond is initially drafted up. By the time the bond actually hits the public, interest rates have usually changed.
That is why most bonds are either issued at either a premium or a discount. Since the stated interest rate of the bond can’t be changed at this point, the sales price of the bond is changed. A bond issued at a premium sells for more than the stated value. In other words, a $1,000 bond might sell for $1,100. A discounted bond is the opposite. The sale price is actually reduced lower than the stated price. A $1,000 bond might only sell for $900.
In an effort to get away from this problem, some companies don’t issue bonds with stated interest rates or zero-coupon bonds.
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This glossary post was last updated: 28th December, 2021 | 0 Views.