What Are Zero Coupon Bonds?

What are Zero Coupon Bonds?  Zero coupon bonds are bonds which do not make interest payouts, known as coupon payments, to the bond holder.  Instead the bond holder buys the bond at a discount price off the face value amount, earning zero coupon bonds the nicknames discount bonds or even deep discount bonds.   Essentially the trade-off in a discount bond is one makes their money, what would be in essence interest of their investment, from the difference between what they pay for the bond below its par value and the amount they receive, the face value, when the bond reached maturity.  Deep discount bonds were once very popular in the 1960’s when there existed a very significant tax loophole: no income taxes paid on the profit from discount bonds.  This loophole has since been closed and zero coupon bond holders now are taxed on the amount of money they make over their initial investment amount as income.

Deep Discount Bonds In The Market

In the marketplace deep discount or zero coupon bonds take on different roles.  These bonds can be issued short or long term.  They can be any time of bond in the bond marketplace; they simply must be stripped of their coupon payments to fit the parameters of a discount bond.  Short term zero coupon bonds issued by the US Treasury department are referred to as bills.  Currently these bills make up the largest market share of discount bonds.  Long-term zero coupon bonds can run anywhere from 10-15 years in maturity length.  Most of these bonds are traded on the secondary bond market and the original investor is rarely the same who holds the bond when it matures.  As bond rates rise or fall bond investors will look to sell these discount bonds at a profit or invest in them when their value is lowered.

Related posts:

1. What Are Strip Bonds?
2. What Are Tax Free Bonds?
3. What Are Convertible Bonds?
4. How Are Bonds Funded?
5. What Is Bond Maturity?