Zero Coupon Bonds

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Definition: Zero Coupon Bonds

Zero Coupon Bonds are deep discount bonds that do not pay any interest during the lifetime of the bond. It is traded at a discounted value, giving profits when matured when the bond can be redeemed for its complete face value. This is under the assumption of positive time value of money.

Examples of Zero Coupon Bonds include US Treasury Bills, US Savings bonds, etc. ZCBs may be long term or short term investments. Long term zero coupon bonds are for ten to fifteen years while the short term zero coupon bonds are for less than a year and are called Bills. ZCBs can be held till maturity or can be traded in secondary bond markets. US Treasury Bill market is the most liquid and active debt market in the world.

Pension funds and insurance companies generally deal in ZCBs due to their long term to maturity and high durations of the bonds. Some ZCBs are sold as is while some are repackaged coupon bonds issued by financial institutions. Since the bulk payment comes at the end of maturity, ZCBs are more price-volatile than coupon bearing bonds.

The price of a ZCB is calculated as –

Price = FV / (1 + r)t

Where, FV = Face value at maturity

r = annual yield / 2

t = number of year till maturity * 2

Hence, this concludes the definition of Zero Coupon Bonds along with its overview.

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