What does "Zero-coupon Bonds" mean?
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Zero-coupon bonds are a type of bond that does not pay interest like traditional bonds. Instead, they are sold at a lower price than their face value. When the bond matures, the holder receives the full face value. The difference between the purchase price and the face value is the profit the investor earns.
How They Work
For example, if you buy a zero-coupon bond for $700 that will be worth $1,000 in ten years, you are making a $300 profit when the bond matures. This means you are essentially lending money to the issuer of the bond without receiving regular interest payments.
Why Invest in Zero-Coupon Bonds?
One reason to invest in zero-coupon bonds is that they can be a good way to save for a future goal. Since you know exactly how much you will receive at maturity, it makes planning easier. They are also less sensitive to interest rate changes compared to regular bonds, which can help reduce risk.
Who Uses Zero-Coupon Bonds?
These bonds are often used by investors looking for long-term investments, such as saving for college tuition or retirement. They can also be a part of a diversified investment portfolio, helping balance out other types of investments.
Key Points to Remember
- No regular interest payments.
- Sold for less than face value.
- The profit is the difference between purchase price and face value.
- Good for long-term savings goals.