Zero Coupon Bonds

Zero coupon bond is a bond that generates no periodic interest’s payments during its life time. Zero coupon bonds are at a deep discount from their face value. The holder of a zero-coupon bond only receives the face value of the bond at maturity. When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus interest that has accrued. The maturity dates on zero coupon bonds are usually long-term. With the deep discount, an investor can put up a small amount of money that can grow over many years.

The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons, or interest payments, to the bondholder while a typical bond does make these interest payments. A coupon-paying bond will initially trade near the price of its face value. In other words, a zero-coupon bond gains from the difference between the purchase price and the face value, while the coupon bond gains from the regular distribution of interest. Zero-coupon bondholders gain on the difference between what they pay for the bond and the amount they will receive at maturity.

Zero coupons tend to fluctuate in price much more than other type of bonds.