What is Zero-coupon bond?
A zero-coupon bond is an effective way to earn interest on a fixed principal amount. Rather than promising to pay regular coupon payments, a zero-coupon bond instead provides a single payment at the maturity date, equal to the face value of the bond plus its accumulated interest. Zero-coupon bonds are generally more attractive for accredited investors who want to achieve higher long-term yields with lower tax obligations.
For example, if a zero-coupon bond has a face value of INR 1,000 and it is issued at a price of INR 900, the investor will receive INR 1,000 when the bond matures.
How to invest in Zero-coupon bond?
To invest in a zero-coupon bond, you can buy the bond from a brokerage firm or directly from the issuer. You can also buy zero-coupon bonds through a mutual fund or exchange-traded fund (ETF) that invests in zero-coupon bonds. Before investing, you should carefully consider the risks associated with zero-coupon bonds, such as the risk of default and the risk of changes in interest rates. You should also consider the tax implications of investing in zero-coupon bonds, as they are subject to federal income tax on the interest they accrue each year, even though the interest is not paid out until the bond matures.
Risks and Returns associated with Zero-coupon Bond Investment
Investing in zero-coupon bonds is an excellent way of providing long-term, stable income with very little risk. Because they have no periodic payments and no face value to adjust for, investors are able to expect a fixed return depending on the amount it was purchased for and when it matures. Zero-coupon bonds guarantee that the investment will be secure and cannot go down in value before maturity. However, because of these affordability and stability features, there is not as much potential gain as one might find while investing in other strategies.