By Sunita Sethi Leave a Comment. Risk Management Basics. Zero Coupon Bond Also known as Pure Discount Bond or Accrual Bond refers to those bonds which are issued at a discount to its Par Value and makes no periodic interest payment unlike a normal coupon bearing Bond. In other words, its annual implied interest payment is included in its Face Value which is paid at the maturity of such bond.
The Zero Coupon Bond: Pricing and Charactertistics
Calculating Yield to Maturity of a Zero-Coupon Bond
Zero-coupon bonds do not have re-occurring interest payments, which distinguishes yield to maturity calculations from bonds with a coupon rate. Zero-coupon bonds trade on the major exchanges. They are commonly issued by corporations, state and local governments, and the U. The IRS calls this imputed interest. Others find the securities well suited for achieving long-term financial goals, such as college tuition.
A zero coupon bond is a fixed income security that is created from the cash flows that make up a normal bond. It can be a useful option for investors who like knowing they will receive a certain amount of set income at a certain time, without having to spend too much time thinking about their portfolio. This means an investor knows his return in advance if he holds a zero coupon to maturity.
Bond mathematics tend to be easier to calculate on a spreadsheet as seen below:. You can see the parameters used in the above image as well viz. Usually, you would want to confirm the answer calculated. So using the time value of money concept and discounting the cash flows for 8 years in this context 0 and face value only at the eighth year using the YIELD calculated i.