Zero-coupon bonds, unlike other regular bonds, are one of the fixed-income securities that don’t pay interest. It is illustrated, in that, it generates return at maturity rather than the regular periodic payment. These bonds do not provide income payment at intervals, unlike the other type of bonds, and this has made them unpopular. This trend has discouraged the majority of investors. However, some investors consider investing in the zero-coupon bond as an opportunity to reach their long-term financial achievement or goals in a slightly less risky way. (Auclert, 2019)
The formula used to calculate zero-coupon bonds ‘P=M/(1+r‘. P represents the price; M is the maturity level of the bond; r repinvestor’se investor’s required annual yield/2 or the semi-annual yield and lastly n is the (number of years until the maturity) *2 (Choi et al, 2007). The Corporations and Government issues zero-coupon bonds making these bonds become very popular and very common. However, corporate zero-coupon are very riskier to invest because when the corporate defaults, then the holders of the bond lose more. Surprisingly, Coupon-based bonds pay the regular payment in the form of interest. Zero-coupon bonds investors profit from the difference of the buying price and face value when the bond hits maturity (Veronesi, 2010).
Advantages
The investors are subjected to capital gains tax, implying that even if there is a sharp fall in the interest rate thedon’testors don’t have to pay any tax on the interest. This is because bonds are issued at a discounted price, that is, they are bought at a fraction of the intended face value. For instance, a $20,000 bond can be purchased at less than half of the amount.
If the zero-coupon is issued by a government entity, the interest generated is exempted from the income tax. This increases the earning percentage for investors.
Long term investors who invest in coupon bonds are issued with maturities of 15-20 years. The longer the length in years of the bond the less the amount the investor has to pay. They become a good investment option for investors who would require future funds like education for their children or It’srement.
It’s the best investment for those indon’trs who don’t close the markaren’tnd or aren’t interested in watching the market trend. These kinds of investors bel’eve in the ‘inves’ and forget’ program. This kind of investor most likely does not know the existing trend due to illiteracy or ignorance and thus, this investment plan favours them.
Zero-coupon generally holds fewer risks as compared to other fixed-income securities, and this makes it serve as an option to significant investment that can be used to attain long term financial goals. This investment can utilize to secure a return for a fixed period and also certainly perfect for long-term investment plans.
Risks involved
Zero-coupon bond rates depend entirely on interest rates. Due to the appreciation and depreciation of the interest rates, then the market value of the bond fluctuates about the coupon rates, which are higher or lower from current interest rates. The daily price of the bonds varies daily. Investors selling them before maturity receive slightly less money than they originally paid for them.
The investor must maintain their bond until the maturity date to receive profit. noted to why they have reduced the price of the market by its value of the par. However, other zero-coupon may not buy from creditworthy entities may not reach maturity for decades.