Zero-Coupon Bond
Sold at a deep discount, pays no interest, matures at par.
What is Zero-Coupon Bond?
The entire return comes from the accretion between purchase price and par. With no coupons there is no reinvestment risk, but duration equals maturity, so zeros are the most price-sensitive bonds for any given maturity. The annual accretion is taxable each year (phantom income) unless the zero is a municipal or is held in a tax-advantaged account. Treasury STRIPS are the best-known example.
Zero-Coupon Bond: a worked example
A 20-year zero bought at $450 matures at $1,000; the holder is taxed on accretion each year without receiving cash.
More terms in Bonds & Cash Equivalents
Certificate of Deposit (CD)
A bank time deposit paying a fixed rate for a fixed term, FDIC insured.
Commercial Paper
Unsecured short-term corporate debt, 270 days or less.
Treasury Inflation-Protected Securities (TIPS)
Treasuries whose principal adjusts with the CPI.
Asset-Backed Securities (ABS / MBS)
Bonds backed by pools of loans - mortgages, auto loans, credit cards.
General Obligation (GO) Bond
A municipal bond backed by the issuer's full faith, credit, and taxing power.
Revenue Bond
A municipal bond repaid only from the revenue of a specific project.
Insured Municipal Bond
A muni with third-party insurance guaranteeing principal and interest.
Municipal Bond Tax Treatment
Interest usually federally tax-free; gains are not.