Zero coupon Bond

A Zero Coupon Bond is a debt security that is sold at a discount and does not pay any interest payments to the bondholder. In other words, it’s a bond that sells for less than its face value and does not make coupon payments or periodic interest payments during its life. At maturity, it can then be redeemed at its face value allowing the bond holder to make a profit.

Companies, schools, and governments use bonds as a way to finance expansions and other long term projects. Usually the decision to issue a bond starts with a proposal for new projects. When the board or governing body approves the plans, a bond can be issued. Unfortunately, it isn’t that easy. Sometimes it can take a few months for the bond to be drafted and actually issued to the public. This presents a problem. The interest rate and terms of the bond are set when the bond is initially drafted up. By the time the bond actually hits the public, interest rates have usually changed. That is why most bonds are either issued at either a premium or a discount. Since the stated interest rate of the bond can’t be changed at this point, the sales price of the bond is changed. A bond issued at a premium sells for more than the stated value. In other words, a $1,000 bond might sell for $1,100. A discounted bond is the opposite. The sale price is actually reduced lower than the stated price. A $1,000 bond might only sell for $900.In an effort to get away from this problem, some companies don’t issue bonds with stated interest rates or zero-coupon bonds.