Zero Coupon Security

Debt security that makes no periodic interest payments but is sold at a deep discount from its face value. The bondholder does not receive interest payments, only the full face value at redemption on the specified maturity date. The owner of a zero-coupon bond owes income taxes on the interest that has accrued each year, even though the bondholder does not receive payment until maturity. There are several kinds of zero coupon securities. The most popular is the zero coupon bond. This bond can either be issued by a corporation or by a brokerage firm when it strips the coupons off a bond and sells the principal and the coupons separately. This technique is used frequently with Treasury bonds. Zero coupon bonds are also issued by municipalities. Because zero coupon securities do not make interest payment, they are considered more volatile than bonds making periodic payments. When interest rates rise, zeros fall more sharply than interest paying bonds. However, zero coupon securities rise more rapidly in value when interest rates drop.

« Back to Glossary Index

Comments are closed.