Zero-Coupon Bond

A zero-coupon bond is a debt security that does not pay regular interest payments. Instead, it is issued at a significant discount to its face value and pays the full face value at maturity. The difference between the purchase price and face value represents the investor's return.

For example, a 10-year zero-coupon bond with a face value of $10,000 might be purchased for $6,139. At maturity, the investor receives $10,000, earning $3,861 in implied interest. This structure is attractive for investors with specific future funding needs, such as college tuition.

Zero-coupon bonds are more sensitive to interest rate changes than coupon-paying bonds of similar maturity, making them more volatile. An important consideration is that the IRS taxes the imputed interest annually even though no cash is received, making them best suited for tax-advantaged accounts like IRAs.