What are zero coupon bonds?

A zero-coupon bond (also discount bond or deep discount bond) is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. ┬áNote that this definition assumes a positive time value of money. It does not make periodic interest payments, or have so-called “coupons”, hence the term zero-coupon bond. When the bond reaches maturity, its investor receives its par (or face) value. Examples of zero-coupon bonds include U.S. Treasury bills, U.S. savings bonds, long-term zero-coupon bonds, and any type of coupon bond that has been stripped of its coupons.
In contrast, an investor who has a regular bond receives income from coupon payments, which are made semi-annually or annually. The investor also receives the principal or face value of the investment when the bond matures.
Some zero coupon bonds are inflation indexed, so the amount of money that will be paid to the bond holder is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority of zero coupon bonds pay a set amount of money known as the face value of the bond.
Zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Short-term zero coupon bonds generally have maturities of less than one year and are called bills. The U.S. Treasury bill market is the most active and liquid debt market in the world.

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Published: January 11, 2016 Updated: January 14, 2016