A zero coupon bond is a bond which doesn’t pay any periodic payments. Instead it has only a face value (value at maturity) and a present value (current value). The entire face value of the bond is paid out at maturity. It is also known as a deep discount bond.

What is a zero-coupon bond example?

A zero-coupon bond is a bond that pays no interest and trades at a discount to its face value. It is also called a pure discount bond or deep discount bond. U.S. Treasury bills. are an example of a zero-coupon bond.

Are zero-coupon bonds risk free?

Like virtually all bonds, zero-coupon bonds are subject to interest-rate risk if you sell before maturity. 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.

How to calculate face value of zero coupon bond?

Since the bond compounds semi-annually, we must divide the required rate of return by two and multiply the number of years until maturity by two to account for the total number of periods the bond will be compounded for. John is looking to purchase a zero-coupon bond with a face value of $1,000 and 5 years to maturity.

Why does a zero coupon bond trade at a discount?

Therefore, a zero-coupon bond must trade at a discount because the issuer must offer a return to the investor for purchasing the bond. To calculate the price of a zero-coupon bond, use the following formula:

Is there reinvestment risk in a zero coupon bond?

Reinvestment risk is not relevant for zero-coupon bonds, but interest rate risk is relevant for the bonds. As a zero-coupon bond does not pay periodic coupons, the bond trades at a discount to its face value. To understand why, consider the time value of money

What happens to zero coupon bonds when the Fed raises interest rates?

Zero-coupon U.S. Treasury bonds are also known as Treasury zeros, and they often rise dramatically in price when stock prices fall. Zero-coupon U.S. Treasury bonds can move up more than 50% in just one year when the Fed cuts rates aggressively. Treasury zeros can easily fall 30% or more in a single year if the Fed raises interest rates.