Economics Bonds Questions Long
Zero-coupon bonds, also known as discount bonds or deep discount bonds, are a type of fixed-income security that does not pay periodic interest payments like regular bonds. Instead, these bonds are issued at a discount to their face value and provide a lump sum payment to the bondholder at maturity.
The key difference between zero-coupon bonds and regular bonds lies in the payment structure. Regular bonds typically pay periodic interest payments, known as coupon payments, to bondholders throughout the life of the bond. These coupon payments represent the interest earned on the bond's face value, which is usually paid semi-annually or annually. At maturity, the bondholder receives the face value of the bond.
On the other hand, zero-coupon bonds do not make any periodic interest payments. Instead, they are issued at a discounted price, which is below their face value. The discount is determined by the prevailing interest rates and the time to maturity. The bondholder does not receive any interest income during the life of the bond but receives the full face value at maturity. The difference between the discounted purchase price and the face value represents the bondholder's return or yield.
Another distinction between zero-coupon bonds and regular bonds is the tax treatment. Since zero-coupon bonds do not pay periodic interest, they do not generate any taxable income until maturity. However, bondholders may still be subject to tax on the imputed interest, which is the difference between the purchase price and the face value. Regular bonds, on the other hand, generate taxable interest income throughout their life.
Zero-coupon bonds are often used by investors for specific financial goals. They are commonly employed for long-term financial planning, such as funding education expenses or retirement. These bonds are also popular among institutional investors who have specific future cash flow requirements.
In summary, zero-coupon bonds differ from regular bonds in that they do not pay periodic interest payments. Instead, they are issued at a discount to their face value and provide a lump sum payment at maturity. The absence of periodic interest payments and the discounted purchase price make zero-coupon bonds unique and suitable for specific investment objectives.