Zero-coupon bond

A zero-coupon bond pays nothing until it matures. Instead of coupons, you buy it below its face value and receive the full face value at maturity; the difference is your return. Government securities can be split into separate zero-coupon pieces, known as STRIPS, and some corporate issuers offer deep-discount bonds that work in a similar way.

Why it matters

A zero-coupon bond gives one precise cash flow on a known date, which is useful for matching a specific future expense. With no coupons to reinvest, the YTM at purchase is — if you hold to maturity and the issuer pays — the return you actually receive.

How to read it

• Duration equals maturity. With no interim payments, its duration is the full time to maturity, so its price is more sensitive to interest rates than a coupon bond of the same maturity.
• Price rises towards face value as maturity approaches, all else being equal.
• Compare on yield. Because the price is far below face value, the yield is the only meaningful way to compare one zero-coupon bond with another.

Common misconceptions

• “No coupon means no tax until maturity.” Tax treatment depends on the instrument and current rules, and the gain may be taxed differently from coupon interest. Check the latest provisions.
• “Zero-coupon bonds are low risk.” They carry the issuer’s full credit risk and more interest rate risk than coupon bonds of the same maturity.

In India: The Reserve Bank of India’s STRIPS facility allows eligible government securities to be separated into coupon and principal components that trade as zero-coupon securities.