A coupon is a monthly interest payment received by a bondholder from the moment the bond is issued until it matures. Bondholders receive no interest from zero coupon bonds, commonly known as discount bonds. Instead, you get a significant reduction on the bond’s face value.
The bondholder receives the face value of his investment at maturity. In plain terms, an investor who buys a zero coupon bond earns money from the difference between the purchase price and the face value, rather than from interest.
Is it possible to purchase zero-coupon bonds?
Bonds with a zero coupon pay no interest for the duration of the bond’s existence. Rather, investors purchase zero coupon bonds at a significant discount to their face value, which is the amount the investor would receive when the bond “matures,” or matures.
Zero coupon bonds typically have long maturities, with many lasting ten, fifteen, or even more years. These long-term maturity dates enable a person to save for a long-term objective, such as paying for a child’s college education. A deep discount allows an investor to put up a small quantity of money that will rise over time.
In the secondary markets, investors can purchase several types of zero coupon bonds issued by a range of issuers, including the US Treasury, companies, and state and local government agencies.
Because zero coupon bonds pay no interest until they mature, their prices fluctuate more in the secondary market than other forms of bonds. Furthermore, even though zero coupon bonds do not require payments until they mature, investors may be subject to federal, state, and local income taxes on the imputed or “phantom” interest that accrues each year. Some investors avoid paying taxes on imputed interest by acquiring municipal zero coupon bonds (assuming they live in the state where the bond was issued) or the rare tax-exempt corporate zero coupon bonds.
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.
What is the procedure for purchasing a coupon bond?
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.
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.
What is the formula for calculating a zero-coupon bond?
The price of a zero coupon bond is calculated using a simplified version of the present value (PV) calculation. The formula is price = M / (1 + i)n, where M is the maturity or face value of the security. I is the needed interest yield multiplied by two.
What exactly are the advantages of zero-coupon bonds?
A zero-coupon bond is a low-cost investment that can be used to save for a specific objective in the future. A zero-coupon bond does not pay interest on a regular basis, but instead sells at a substantial discount and pays the full face value at maturity. Zero-coupon bonds are appropriate for long-term, specific financial needs that can be met in the near future.
Are zero-coupon bonds exempt from taxes?
Zero coupon municipal bonds (sometimes known as “zeroes”) are tax-free, intermediate- to long-term bonds that are bought at a considerable discount. Compound interest on zero coupon municipal bonds is exempt from federal income taxes and, in some cases, from state income taxes for residents of the state of issuance.
Why are zero coupon bonds so risky?
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.
How can you figure out how much a coupon bond is worth?
The yield to maturity refers to the estimated profits an investor can expect if he or she holds a bond until it matures. In other words, a bond’s returns are determined after all payments have been made on time over the bond’s tenure. Unlike current yield, which measures the bond’s current value, yield to maturity gauges the bond’s value at the conclusion of the bond’s term.