Zero Coupon Bonds

Zero coupon bonds are unique investments in that they do not accrue interest like some investments. Instead, they are traded at an extreme discount with the true profit occurring when the bond matures and is redeemed for face value.

An example of a zero coupon bond is this: Assume that you have purchased a $1,000 zero coupon bond for $500. Upon its maturity date, it will be worth the $1,000 and you have made a $500 profit.

If you buy a zero coupon bond, you will notice that the price fluctuates quite a bit. This is typical of this type of bond. As a matter of fact, the rate of fluctuation is more intense than regular coupon bonds. As for why they are called zero coupon bonds, it's because the financial institution has issued them as zero coupon bonds or a financial institution has taken away their coupons and repackaged them to be sold as zero coupon bonds. This is one reason why they fluctuate so much because entire payment is made at maturity.

Difference from Coupon Bonds

Coupon bonds offer payments semi-annually. These are frequently referred to as "coupon payments." In addition to these payments, the investor receives the face value of the bond in addition to the semi annual payments that has been made since it was purchased.

Because a zero coupon bond is a coupon bond that has had its coupons stripped from it, it may also be called a "strip bond." Despite the fact that the bond has been stripped of its coupons, it does gain its full value over time.

And since zero coupon bonds have a high duration like annuities, insurance companies and coupon bonds like owning zero coupon bonds that have long maturity. Because they are high duration, they are very sensitive to interest rate changes, which can help to offset the interest rate risks that insurance companies and pension funds tend to face.

Unlike coupon bonds, zero coupon bonds may also be used by analysts and those simply studying the yield curve for educational reasons to analyze the yield curve. There are a number of methods that are used when using the zero coupon bond to analyze the yield curve.

Taxes

It is best if zero coupon bonds are held in retirement accounts that are tax-deferred. This is because the income that is gained from a zero coupon bond before it is cashed in can result in the income being taxed. In other words, the taxes are not deferred like with some types of investments. Basically, the fact that these bonds are not tax deferred means you are paying taxes on future income rather than income you make right now.

In order to handle these bonds correctly, a financial advisor can help you to place the bonds in retirement accounts or other instruments that will allow the bonds to gain toward their face value, thus provide you with future income. You can talk to a financial advisor about the different ways in which these very unique bonds can be used. They do seem rather simple, but you do not want to have to pay for them prematurely, thus offsetting some of the income that you may receive.

So when looking for an affordable and unique investment, zero coupon bonds allow you to buy significantly below face value so that you can later receive the face value as income. You can use them as a method to save for retirement or any other long-term goals that you may have. That way you can make the most of your money and have plenty of methods to save for retirement.

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