Except for zero-coupon bonds, most bonds pay monthly interest or “coupon” payments. Zeros, as they’re known, are bonds that don’t have a coupon or interest payment.
If interest rates rise,
Instead of receiving interest payments, you purchase a zero bond at a discount to its face value and are paid the face amount when it expires. For example, a 20-year zero-coupon bond with a face value of $10,000 might cost $3,500. The bond’s issuer pays you $10,000 after 20 years. As a result, zero-coupon bonds are frequently acquired to cover a future obligation such as college fees or a projected retirement payment.
Zero-coupon bonds are issued by federal agencies, municipalities, financial institutions, and corporations. STRIPS is the name of one of the most common zeros (Separate Trading of Registered Interest and Principal Securities). An eligible Treasury asset can be converted into a STRIP bond by a financial institution, a government securities broker, or a government securities dealer. The bond gets stripped of its interest, as the name implies.
STRIPS have the advantage of not being callable, which means they cannot be redeemed if interest rates decline. If your bond is called, you receive cash, and you need to reinvest it, this feature protects you from having to settle for a lower rate of return (this is known as reinvestment risk).
However, zero-coupon bonds come with a variety of risks. If you sell before maturity, zero-coupon bonds, like practically all bonds, are susceptible to interest-rate risk. If interest rates rise, the secondary market value of your zero-coupon bond will certainly fall. Long-term zeros can be particularly vulnerable to interest rate movements, putting them at danger of what is known as duration risk. In addition, zeros might not keep up with inflation. While Treasury zeros pose little danger of default, default risk should be considered while researching and investing in corporate and municipal zero-coupon bonds.
How can you purchase a Treasury bond with no interest?
With your zero coupon bond order, contact your bank or broker. The bond selling price remains the same regardless of who places your order, but keep in mind that the bond purchase price will include a commission. To save money on your commission charge, go with a discount broker rather than a full-service broker.
Are zero-coupon bonds still available?
Bonds appeal to many investors because of the interest payments they deliver. Purchasing a bond that pays no interest may appear to be a bit of a paradox. However, there is a thriving market for such an instrument: the zero-coupon bond, also known as “zeros.”
Zero-coupon bonds are popular among savvy investors because they can be purchased at a significant discount to their face value, or the nominal amount they’re worth. When they reach maturity, however, you will receive their full face value. So you benefit from the difference between the initial discounted price and the amount you receive when the bond matures.
The most appealing feature of zero-coupon bonds is their dependability. If you hold the bond until it matures, you’ll almost certainly get a good return on your investment. As a result, they’re good for specific financial demands like college tuition or a down payment on a house.
What is a zero-coupon bond’s interest rate?
A zero-coupon bond is a type of debt product that pays no interest. Zero-coupon bonds are sold at a steep discount and pay out the entire face value (par) at maturity. The return on a zero-coupon bond is calculated as the difference between the purchase price and the par value.
Do you sell zero-coupon bonds at Fidelity?
Zero-coupon bonds, commonly known as “Strips,” are bonds that pay no interest on a regular basis (i.e., there is no coupon). Instead, you purchase the bond at a discount and receive a single payment when it matures. The payment is equal to the amount you invested plus the interest you’ve earned (compounded annually to maturity).
A US savings bond, which is a “non-marketable” Treasury instrument that can be purchased directly from the Treasury or from most institutions, is perhaps the most well-known example of a zero-coupon bond. (Fidelity also sells additional zero-coupon Treasury securities that can be bought and sold on the secondary market.) There’s a reason why many parents and grandparents consider these ties to be a favorite present: When you want to save for a certain goal and date, such as when your child attends college, zero-coupon bonds are appealing. At maturity, you will get your principle and interest in one lump sum.
Assume you’re putting money aside for your child’s college education, which will start in ten years. You could buy a $16,000 10-year zero-coupon bond with a face value of $20,000 for $16,000. At the end of ten years, you will receive the face value of $20,000.
There are a few disadvantages to zero-coupon bonds. First, even if you do not collect the interest until maturity, you will almost always have to pay taxes on it annually. If you acquire the bonds in a tax-deferred retirement account or in a custodial account for a kid in a circumstance where the youngster pays little or no tax, this can be offset.
In the open market, zero-coupon bonds can be extremely volatile, making them particularly vulnerable to interest rate risk. It makes no difference if you hold the bond until it matures. However, if you need to sell it quickly, you could lose a lot of money.
Why are zero-coupon bonds priced so low?
The time value of money is a notion that shows that money is worth more now than it will be in the future. For example, an investor would prefer to get $100 now rather than $100 in a year. By obtaining $100 today, the investor can put it in a savings account and collect interest, resulting in a total of more than $100 in a year.
Taking the aforementioned concept further, zero-coupon bonds need an investor to be compensated with a higher future value if they purchase the bond today. Because the issuer must provide a return to the investor for purchasing the bond, a zero-coupon bond must trade at a discount.
What makes a coupon bond different from a zero-coupon bond?
The payment of interest, often known as coupons, distinguishes a normal bond from a zero-coupon bond. A standard bond pays interest to bondholders, whereas a zero-coupon bond does not pay interest to bondholders. Instead, when a zero-coupon bond matures, the holder receives the face value of the bond. Regular bonds, commonly known as coupon bonds, pay interest and repay the principle throughout the course of the bond’s existence.
Who is eligible to issue zero-coupon bonds?
Section 2 (48) of the Income Tax Act now allows only an authorised infrastructure capital firm/fund or a public sector corporation to issue zero-coupon bonds.
Is there such a thing as a zero-coupon Treasury bond?
T-bills are zero-coupon bonds that are typically sold at a discount, with the difference between the purchase price and the par amount representing your interest.
Why are zero-coupon bonds so dangerous?
Because all interest payments on zero coupon bonds are compounded and paid at maturity, they are more sensitive to interest rate changes than bonds that pay interest semiannually. The higher the volatility, the longer the bond’s maturity.