Zero-coupon bonds

Let’s begin by understanding what a zero-coupon bond is. Unlike traditional bonds that pay regular interest—known as coupons—a zero-coupon bond is issued at a deep discount to its face value and makes no periodic interest payments. Instead, the investor receives a single payment, the face value, at maturity. The appeal lies in its simplicity: there are no intermittent payments. The difference between the purchase price and the amount received at maturity reflects the interest earned. Zero-coupon bonds can be issued by governments, corporations, or municipalities. In the United States, government-issued zeros are sometimes called STRIPS, while in the United Kingdom, similar instruments exist with different names. When valuing a zero-coupon bond, the key principle is the time value of money. Since there are no intermediate payments, the full compensation is received at maturity. To find the initial price, the expected yield and the bond’s maturity are used in a present value calculation. For example, a one thousand dollar bond maturing in five years might be purchased for eight hundred fifty dollars. The difference between the purchase price and redemption value is the interest income, accruing over the term. The yield to maturity reflects the average annual return if held to maturity. Zero-coupon bonds serve distinct purposes in financial planning and portfolio construction. Favored by investors seeking a fixed amount at