zero coupon bond
A bond that pays no periodic interest but is issued at a deep discount to face value, with the investor's return being the difference between purchase price and face value at maturity.
Example
“The 10-year zero coupon bond sold for $613 grew to $1,000 at maturity — earning 5% annually with no interim payments.”
Memory Tip
ZERO COUPON bond = no interest payments. Buy cheap, get full face value at maturity. Pure price appreciation.
Why It Matters
Zero coupon bonds matter because they offer a way to invest with predictable returns and no need to reinvest periodic interest payments. They are particularly useful for long-term financial planning, such as saving for a child's education or retirement, since you know exactly how much you will receive at maturity.
Common Misconception
Many people mistakenly believe that zero coupon bonds are risk-free investments because they guarantee a specific payout at maturity. However, they still carry interest rate risk and inflation risk, and if you need to sell before maturity, you may receive less than expected if market rates have changed.
In Practice
Suppose you purchase a zero coupon bond with a face value of 10,000 dollars for 6,100 dollars today, maturing in 10 years. You pay nothing else for 10 years, and at maturity you receive the full 10,000 dollars, netting you a gain of 3,900 dollars on your initial investment without any coupon payments along the way.
Etymology
ZERO COUPON (paying no periodic interest) BOND. A BOND with ZERO (no) COUPON payments.
Common Misspellings
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