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Finance Dictionary and Glossary of Investment Terms
zero-coupon bond
Definition 1.
A bond which pays no coupons, is sold at a deep discount to its face value, and matures at its face value. A zero-coupon bond has the important advantage of being free of reinvestment risk, though the downside is that there is no opportunity to enjoy the effects of a rise in market interest rates. Also, such bonds tend to be very sensitive to changes in interest rates, since there are no coupon payments to reduce the impact of interest rate changes. In addition, markets for zero-coupon bonds are relatively illiquid. Under U.S. tax law, the imputed interest on a zero-coupon bond is taxable as it accrues, even though there is no cash flow.
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Definition 2.
A bond that, instead of paying interest, is sold at a deep discount. You get the face value at maturity, and the difference between the two is the yield. Mostly these are Treasury securities. Zeros, as they are known, have some advantages: you can buy one today that matures when you child is ready for college and know exactly how much money you will have. Zeros pay slightly higher interest than regular bonds, too. But you have to pay taxes on ""imputed"" interest -- money you don''t collect until you redeem the bond.
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Definition 3.
A bond in which no periodic coupon is paid over the life of the contract. Instead, both the principal and the interest are paid at the maturity date.
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Definition 4.
A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value. Also known as an accrual bond.
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