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Last edited 16 May 2018
A zero-coupon bond, also known as a deep discount bond, is a form of debt security that does not pay interest to the bondholder. This is different from a normal bond which does pay interest (coupons). Instead a zero-coupon bond is traded at face value when the bond matures.
The profit gained by investors is derived from difference between what they pay for the bond and the amount they sell it for at maturity. This difference is achieved in part because of the large (or deep) discount that a zero-coupon bond is purchased at.
An example is a zero-coupon bond issued at £50 and sold for £100 after seven years. This would have offered a return equivalent to over 10% per year compound over the seven years of the bond. In the UK as in many other countries, some of the capital gain on a zero-coupon bond is treated as taxable income.
A zero-coupon bond can be useful in property financing as income is often in short supply in the early years of a project. However, it is considered a riskier investment than regular bonds because if the bond issuer defaults, the investor will lose all their investment and won’t have even received interest payments.
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