Zero Coupon Bond
In
Fixed Income markets, instruments such as
bonds and
notes make periodic payments of
interest to their owners, until what is known as the
maturity date.
Payments are received at predetermined intervals which are defined by the instruments type. For example,
US Government securities such as Treasury bonds will pay their owners twice a year - or
semiannually - while
Corporate bonds will pay only once a year.
A zero coupon bond makes no payments of
interest during it's lifetime. Instead, the owner of such an instrument receives a single payment at the
maturity date of the instrument.
Typically a zero coupon bond is priced at a
deep discount to it's
redemption or
par value. The difference between par and the purchase price is effectively the interest received by the ower, for acquiring the instrument.
A
bill is identical to a zero coupon with the exception of the maturity or lifetime of the instrument. Zero coupon bonds typically are issued for thirty years, while bills are issued for much shorter periods - one year or less.
A zero coupon bond is also known as a
strip for a curious historical reason. In modern times few bonds are
physically issued - instead
ownership is recorded on a register.
Before the development of adequate
computer power, bonds
were physically issued and retained by the owner. Each bond consisted of a series of
coupons which were
clipped, or removed by the owner and presented for payment.
A zero coupon bond, then, is nothing more than a bond with the coupons removed, or
striped. This, as previously explained, entitles the owner to a single payment at maturity of the instrument.