Corporate zero coupon bond maturing in ten years
- Using a bond's duration to gauge interest rate risk;
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To find the zero coupon bond's value at its original price, the yield would be used in the formula. After the zero coupon bond is issued, the value may fluctuate as the current interest rates of the market may change. The formula would be shown as.
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Duration: Understanding the Relationship Between Bond Prices and Interest Rates - Fidelity
When considering this site as a source for academic reasons, please remember that this site is not subject to the same rigor as academic journals, course materials, and similar publications. The investors earn a return in the form of coupon payments made annually or semi-annually throughout the life of the bond. When the bond matures , the bondholder is repaid an amount equal to the face value of the bond. If a corporate bond is issued at a discount , this means investors can purchase the bond below its par value.
But not all bonds have coupon payments. Such bonds are referred to as zero coupon bonds. These bonds are issued at a deep discount and repaid the par value at maturity.
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The difference between the purchase price and the par value represents the investor's return. The payment received by the investor is equal to the principal invested plus the interest earned, compounded semiannually, at a stated yield. The interest earned on a zero-coupon bond is an imputed interest , meaning that it is an estimated interest rate for the bond, not an established interest rate. So, although no coupon payments are made on zero coupon bonds until maturity, investors may still have to pay federal, state, and local income taxes on the imputed or phantom interest that accrues each year.
Zero Coupon Bond Effective Yield
Purchasing a municipal zero coupon bond, buying zero coupon bonds in a tax-exempt account, or purchasing a corporate zero coupon bond that has tax-exempt status are a couple of ways to avoid paying income taxes on these securities. The greater the length of time until the bond matures, the less the investor pays for it, and vice versa. The maturity dates on zero coupon bonds are usually long term, with many having initial maturities of at least 10 years.
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