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Definition: Zero Coupon Convertible Bond
This is a fixed income instrument which is a hybrid of zero coupon bonds with an added flexibility to convert the bonds into shares. The holder of the zero coupon bond don’t earn interest, rather the bonds are available at deep discount from their face value. Over the life of the bond, interest is accrued and added to the bonds carrying value.
At maturity, the bonds carrying value is equal to its face value. Thus it provides capital appreciation rather than interest income. However as the bonds are not providing a steady flow of interest income to the bond holder, it is available at deeper discounts or for a higher yield. The convertible feature allows the holder to convert bonds into equivalent shares.
This provides an opportunity to bond holder to convert into shares when he expects the shares to appreciate significantly. As such bonds come with an added feature of convertibility, they generally come at yield. Thus the higher yield of zero coupon and lower yield of convertible bond cancels each other.