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

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

The main difference between a zero-coupon bond and a coupon bond lies in the way they generate returns for investors.

A zero-coupon bond, also known as a discount bond, does not pay periodic interest payments (coupons) to the bondholder. Instead, it is issued at a discount to its face value and matures at its full face value. The return on a zero-coupon bond comes from the difference between the purchase price and the face value when it matures. This means that the bondholder receives a lump sum payment at maturity, representing the interest earned over the bond's life.

On the other hand, a coupon bond, also known as an interest-bearing bond, pays periodic interest payments (coupons) to the bondholder throughout its life. These interest payments are typically made semi-annually or annually and are based on a fixed percentage of the bond's face value. The bondholder receives these coupon payments until the bond reaches its maturity date, at which point the face value is repaid.

In summary, the key difference is that zero-coupon bonds do not pay periodic interest payments, while coupon bonds do.