Zero-coupon Bond

A zero-coupon bond is a bond that does not pay interest but instead is sold at a discount, i.e., for less than its face value. For example, a zero-coupon bond with a face value of $5,000 may sell for only $4,200. When the zero-coupon bond matures years later, the bond buyer receives the full $5,000; the $800 difference is the “interest” earned on the zero-coupon bond. A well-known example of a zero-coupon bond is the series EE savings bond sold by the U.S. Treasury. This bond sells for half its face value, which ranges as high as $10,000. One advantage to issuing a zero-coupon bond is that the issuer does not need to make periodic interest payments to its bondholders. One possible disadvantage to bond investors is that zero-coupon bond prices are more volatile on the secondary bond market, since the lack of periodic interest payments is viewed as risky. A zero-coupon bond is also known as an accrual bond.

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