Definition
Zero-coupon bonds (zeros) are issued at a discount to face value and make no coupon payments. The return comes entirely from price appreciation as the bond approaches maturity. Zeros have duration equal to their maturity, making them the most interest rate-sensitive bonds of any given maturity—ideal for liability matching or speculating on rate changes.
functions Formula
Price = Face Value / (1 + r)^n
lightbulb Example
A 20-year zero-coupon bond with face value $1,000 and yield of 5%. Price = $1,000/(1.05)^20 = $376.89. The $623.11 discount accretes to par over 20 years.
verified_user Key Points
- Maximum interest rate sensitivity (duration = maturity)
- No reinvestment risk since there are no coupons
- Phantom income taxed annually despite no cash received
- Treasury STRIPS are government zero-coupon bonds