Zero Coupon Bonds

A zero-coupon bond (also called a deep discount bond, strip bond, or pure discount bond) is a fixed-income security that does not pay periodic interest. Instead, it is issued at a significant discount to its face value and repaid in full at maturity.

For example, a ₹1,000 face value zero-coupon bond might be issued at ₹600 today. At maturity, you receive ₹1,000 — the difference being your return.

Key points:

• No periodic interest (no coupon payments)

• Sold at a discount to face value

• Maturity can range from short-term to 30+ years

• Sensitive to interest-rate changes (high duration)

Zero-coupon bonds earn returns through capital appreciation. The interest is imputed — meaning it accrues over time but is not paid out until maturity.

Example:

If you invest ₹50,000 in a 10-year zero-coupon bond at a 7% yield, you may receive ~₹1,00,000 at maturity.

Formula to calculate price:

Price=Face Value(1+r)n\text{Price} = \frac{\text{Face Value}}{(1 + r)^n}Price=(1+r)nFace Value

Where

• r = yield to maturity (YTM)

• n = number of years until maturity

Predictable Lump-Sum Returns

Perfect for goal-based investing (education, marriage, retirement), since you know exactly how much you'll receive at maturity.

No Reinvestment Risk

Since there are no periodic interest payments, you don't face the risk of reinvesting coupons at lower rates.

Lower Initial Investment

Buying at a discount makes them more accessible than traditional bonds.

Interest-Rate Sensitivity:

Prices fall sharply when interest rates rise, especially for long-maturity zero-coupon bonds.

Liquidity Risk:

May be harder to sell before maturity compared to actively traded coupon bonds.

• Long-term investors with specific financial goals

• Investors are comfortable with interest-rate risk in exchange for a higher certainty of a lump-sum payout

• Investors in higher tax brackets who wish to pay taxes at lower rates, since the returns from the notified zero-coupon bonds are taxed as capital gains