Zero coupon bonds do not make periodic interest payments. Instead, they are issued at a discount to face value and appreciate toward par over time. The pricing formula is straightforward: Price = FV / (1 + r)ⁿ, where FV is the face value, r is the annual yield, and n is the years to maturity. The entire return comes from the difference between the purchase price and the face value received at maturity.

Because all cash flow is concentrated at maturity, zero coupon bonds have the highest duration and convexity of any bond with the same maturity. Their Macaulay Duration equals the time to maturity, making them extremely sensitive to interest rate changes. A 20-year zero coupon bond will experience roughly twice the price volatility of a 20-year coupon bond when yields shift.

Treasury STRIPS are the most common zero coupon bonds, created by separating the coupon and principal payments of Treasury securities. Despite paying no periodic income, zero coupon bond holders owe annual taxes on the imputed (phantom) interest, which is the yearly accretion in value. This makes them popular for tax-advantaged accounts like IRAs where phantom income taxation is deferred.