What is the payment on a zero-coupon bond?
A zero-coupon bond does not pay interest but instead trades at a deep discount, giving the investor a profit at maturity when they redeem the bond for its full face value.
Do zero-coupon bonds pay interest at maturity?
A regular bond pays interest to bondholders, while a zero-coupon bond does not issue such interest payments. Instead, zero-coupon bondholders merely receive the face value of the bond when it reaches maturity.
How do you calculate the yield on a zero-coupon bond?
To calculate the yield-to-maturity (YTM) on a zero-coupon bond, first divide the face value (FV) of the bond by the present value (PV). The result is then raised to the power of one divided by the number of compounding periods.
Why would a company issue a zero-coupon bond?
After 20 years, the issuer of the bond pays you $10,000. For this reason, zero-coupon bonds are often purchased to meet a future expense such as college costs or an anticipated expenditure in retirement. Federal agencies, municipalities, financial institutions and corporations issue zero-coupon bonds.
Why do zero-coupon bonds sell at a discount?
A zero coupon bond generally has a reduced market price relative to its par value because the purchaser must maintain ownership of the bond until maturity to turn a profit. A bond that sells for less than its par value is said to sell at a discount.
What happens when you sell a zero-coupon bond early?
Like virtually all bonds, zero-coupon bonds are subject to interest-rate risk if you sell before maturity. If interest rates rise, the value of your zero-coupon bond on the secondary market will likely fall.
How do you calculate a zero-coupon bond in Excel?
You can calculate the price of this zero coupon bond as follows: Select the cell you will place the calculated result at, type the formula =PV(B4,B3,0,B2) into it, and press the Enter key.
What is a disadvantage of zero-coupon bonds?
Cons of Zero-Coupon Bonds Taxation on Phantom Interest: Zero-coupon bonds do not pay any interest to investors. However, the interest does accrue over the years. Now, investors may have to wait long term to receive their share of the interest. However, governments do not want to wait for receiving their share of taxes.
Why is a zero-coupon bond risk free?
Zero-coupon bonds are the only type of fixed-income investments that are not subject to investment risk – they do not involve periodic coupon payments. Interest rate risk is the risk that an investor’s bond will decline in value due to fluctuations in the interest rate.
How do you find the fair price of a zero coupon bond?
The basic method for calculating a zero coupon bond’s price is a simplification of the present value (PV) formula. The formula is price = M / (1 + i)^n where: M = maturity value or face value. i = required interest yield divided by 2.
Why do zero-coupon bonds have high risk?
If interest rates rise, the value of your zero-coupon bond on the secondary market will likely fall. Long-term zeros can be particularly sensitive to changes in interest rates, exposing them to what is known as duration risk. Also, zeros may not keep pace with inflation.
What is the duration of zero-coupon bond?
Because zero coupon bonds make no coupon payments, a zero coupon bond’s duration will be equal to its maturity. The longer a bond’s maturity, the longer its duration, because it takes more time to receive full payment.