What is the difference between a zero-coupon bond and a coupon bond?

A zero-coupon bond and a coupon bond are two different types of bonds that differ in terms of their payment structure and the way they generate returns for investors.

1. Zero-Coupon Bond:
A zero-coupon bond, also known as a discount bond, is a type of bond that does not pay periodic interest payments (coupons) to the bondholder. Instead, it is issued at a discount to its face value and pays the full face value at maturity. The primary characteristic of a zero-coupon bond is that it does not provide any regular income to the investor during its term. The return on investment for a zero-coupon bond comes from the difference between the discounted purchase price and the face value received at maturity. This difference represents the interest earned over the bond's life.

2. Coupon Bond:
A coupon bond, also referred to as an income bond or a bearer bond, is a type of bond that pays periodic interest payments, known as coupons, to the bondholder. These coupons are typically paid semi-annually or annually and represent a fixed percentage of the bond's face value. The bondholder receives these coupon payments until the bond reaches maturity, at which point the face value is repaid. The return on investment for a coupon bond comes from both the periodic coupon payments and the repayment of the face value at maturity.

In summary, the key difference between a zero-coupon bond and a coupon bond lies in their payment structure. A zero-coupon bond does not provide regular interest payments but generates returns through the difference between the discounted purchase price and the face value at maturity. On the other hand, a coupon bond pays periodic interest payments to the bondholder, in addition to the repayment of the face value at maturity.