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Definition: Zero Coupon Bond
It is a type of bond which doesn’t pay any interest (coupon). It is traded at discount to face value such that buyer of the zero coupon bond profits at the time of maturity when the bond is redeemed for its full face value. It is also known as accrual bond.
A 5 year zero coupon bond is issued with a face value of $100 and the interest rate is 6%. The original price of bond will be $100/(1.06)^5
After solving the equation, the original price or value would be $74.73. After 5 years, the bond could then be redeemed for the $100 face value. Sometimes the bonds are issued at discount to the original price i.e. less than the original price of 74.73. These bonds will give overall yield of more than 6%.