Zero-coupon bond

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A zero-coupon bond, or a zero, is a debt security paying no interest at all. Literally it has no coupons.

Why would someone buy a bond paying no interest? Because it issues at a discount to its face value, that’s why. The interest yield is priced into that discount therefore.

Why a zero-coupon bond and not a note? Because the implied interest rate on discounted note is fixed at issuance, meaning the present value will fluctuate depending on prevailing interest rates and not just the credit outlook for the issuer; it isn’t adjusted to reflect prevailing rates or, in the lingo, floating. A rate of zero is a fixed rate, not a floating rate.

And, by market convention, bonds are fixed rate instruments, where as notes are floating rate instruments.

There you go: you learn something every day.

See also

• The wonderful world of debt securities: Bonds | Notes | Certificates | Zero-coupon bonds | Medium term notes | repackagings | Convertible bonds | Exchangeable bonds | Collateralised debt obligations
• Equities: Warrants | Shares