Zero coupon bonds are bonds which do not pay periodic coupons, or so-called "interest payments." Zero coupon bonds are purchased at a discount from their value at maturity. The holder of a zero coupon bond is entitled to receive a single payment, usually of a specified sum of money at a specified time in the future. Some zero coupon bonds are inflation indexed, so the amount of money that will be paid to the bond holder is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority of zero coupon bonds pay a set amount of money known as the face value of the bond. In finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon). ... In finance, interest has three general definitions. ... Inflation-indexed bonds (also known as linkers) are bonds whose principal are indexed to inflation, cutting out inflation risk. ... In economics, purchasing power refers to the amount of goods and services a given amount of money -- or, more generally, liquid assets -- can buy. ... Face Value is the title of Phil Collins debut solo album, released in February of 1981. ...

In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures.

Zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Maturity date is a term in finance - a date when a bond could be called. ... The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. ...

Short term zero coupon bond generally have maturities of less than one year and are called bills. The U.S. Treasury bill market is the most active and liquid debt market in the world. Treasury Securities are bonds issued by the U.S. Federal Reserve. ...

Strip bonds

Investment bankers or dealers may separate the coupons from the bond principal, which is known as the residue, so that different investors may receive the principal and each of the coupon payments. This creates a supply of new zero coupon bonds.

The coupons and residue are sold seperately to investors. Each of these investments then pays a single lump sum. This method of creating zero coupon bonds is known as stripping and the contracts are known as strip bonds. Strtip stands for Separate Trading of Registered Interest and Principal Securities.

Dealers normally purchase a block of high-quality and non-callable bonds - often government issues - to create strip bonds. A strip bond has no reinvestment risk because the payment to the investor only occurs at maturity.

The impact of interest rate fluctuations on strip bonds, known as the bond duration, is higher than for a coupon bond. A zero coupon bond always has a duration equal to its maturity, a coupon bond always has a lower duration. Strip bonds are normally available from investment dealers maturing at terms up to 30 years. For some Canadian bonds the maturity may be over 90 years. In economics and finance, bond duration is the weighted average maturity of a bond or series of cash flows received. ...

In Canada, investors may purchase packages of strip bonds, so that the cash flows are tailored to meet their needs in a single security. These packages may consist of a combination of interest (coupon) and/or principal strips.

In New Zealand, bonds are stripped first into two pieces - the coupons and the principal. The coupons may be traded as a unit or further subdivided into the individual payment dates.

In most countries, strip bonds are primarily administerd by a central bank or central securities depository. An alternative form is to use a custodian bank or trust company to hold the underlying security and a transfer agent/registrar to track ownership in the strip bonds and to administer the program. Physically created strip bonds (where the coupons are physically clipped and then traded separately) were created in the early days of stripping in Canada and the U.S., but have virtually disappeared due to the high costs and risks associated with them. For other uses, see United States (disambiguation) and US (disambiguation). ...

Uses

Pension funds and insurance companies like to own long maturity zero coupon bonds because of the bonds' high duration. This high duration means that these bonds' prices are particularly sensitive to changes in the interest rate, and therefore offset, or immunize the interest rate risk of these firms' long-term liabilities. A pension (also known as superannuation) is a retirement plan intended to provide a person with a secure income for life. ... Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of potential financial loss. ... In economics and finance, bond duration is the weighted average maturity of a bond or series of cash flows received. ... In finance immunization is the matching of the term (life) of an asset to the term (life) of the liability it is intended to pay off. ...

Yield curve traders and academics use zero coupon bonds to precisely analyze the yield curve. Coupon bonds inherently mix different cash flows and interest rates, but by limiting cash flows to a single payment, zero coupon bonds enable analysts to separate out the effect of a single interest rate for each time period. // The Yield Curve & The Term Structure of Interest Rates The US dollar yield curve as of 9 February 2005. ...

Taxes

Even though these bonds don't pay periodic interest, the holder may be liable for imputed income (sometimes called phantom income.) [1] Because of this, zero coupon bonds should generally be held in tax-deferred retirement accounts, to avoid paying taxes on future income.

Alternatively, if you purchase a zero coupon bond issued by a state or local government entity, the imputed interest is free of federal taxes, and in most cases, state and local taxes, too.