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Zero Coupon Bond (Definition, Formula, Examples, Calculations)
Spot Rate: What's the Difference? Partner Links. Related Terms Deep-Discount Bond A deep-discount bond is a bond that sells at a significant lesser value than par. Bond valuation is a technique for determining the theoretical fair value of a particular bond.
Discount In finance, discount refers to a situation when a bond is trading for lower than its par or face value. Strip Bond A strip bond is a bond where both the principal and regular coupon payments--which have been removed--are sold separately. Deferred Interest Bond Deferred interest bond is a debt instrument that pays interest in full only upon maturity.
Unlike most bonds, a deferred interest bond does not make periodic coupon payments over its lifetime. M is the face value at maturity, i is the desired yield divided by 2, and n is the number of years remaining until maturity times 2. This formula can show the maximum price to pay to achieve a desired yield or calculate the yield an investor will earn based on a specific purchase price.
Zero Coupon Bond: Definition, Formula & Example
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- The Zero Coupon Bond: Pricing and Charactertistics.
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Try it risk-free for 30 days. Add to Add to Add to. Want to watch this again later? Zero coupon bonds are an alternative investment type compared to traditional bonds. In this lesson, we will explore what makes these investments unique and how investors can calculate a purchase price or yield of these bonds. Zero Coupon Bonds Most bonds make periodic interest payments to pay back bondholders for borrowing money.
Definition A zero coupon bond is a type of bond that doesn't make a periodic interest payment. Pricing Maturity dates and interest rates dictate the price of zero coupon bonds. Formula and Example The basic method for calculating a zero coupon bond's price is a simplification of the present value PV formula. Try it risk-free No obligation, cancel anytime. Want to learn more? Lesson Summary A zero coupon bond is a bond that doesn't make any periodic interest, or coupon, payments and instead pays only the full face value on its maturity date.
Register to view this lesson Are you a student or a teacher? I am a student I am a teacher. Unlock Your Education See for yourself why 30 million people use Study. Become a Member Already a member? What teachers are saying about Study. Earning Credit. Earning College Credit Did you know… We have over college courses that prepare you to earn credit by exam that is accepted by over 1, colleges and universities. Although the lack of current income provided by zero-coupons bond discourages some investors, others find the securities ideal for meeting long-range financial goals like college tuition.
The deep discount helps the investor grow a small amount of money into a sizeable sum over several years. Because zero-coupon bonds essentially lock the investor into a guaranteed reinvestment rate , purchasing zero-coupon bonds can be most advantageous when interest rates are high.
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They are also more advantageous when placed in retirement accounts where they remain tax-sheltered. Some investors also avoid paying taxes on imputed interest by buying municipal zero-coupon bonds, which are usually tax-exempt if the investor lives in the state where the bond was issued. The lack of coupon payments on zero-coupon bonds means their worth is based solely on their current price compared to their face value. Thus, prices tend to rise faster than the prices of traditional bonds when interest rates are falling, and vice versa.
The locked-in reinvestment rate also makes them more attractive when interest rates fall. Show 5 More. Our in-depth tools give millions of people across the globe highly detailed and thoroughly explained answers to their most important financial questions.
Each month, more than 1 million visitors in countries across the globe turn to InvestingAnswers. Financial Dictionary Calculators Articles. Zero-Coupon Bond.