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Zero coupon bond

A zero coupon bond is a debt instrument that pays no interest. Instead its price is deeply discounted when issued, but at maturity, the bond is refunded at the full face value. Hence, the bond pays accumulated interest in a single lump sum payment at maturity. The bond is so named because the coupon rate (the amount of interest paid) is zero. Rather than paying interest on a periodic basis, these bonds are issued at a fraction of their par value and increase in value as they approach maturity (e.g., U.S. savings bonds). Also known as an accrual bond. Also called zeros.

Expanded Definition

Some prefer zero coupon bonds because the interest is effectively reinvested and compounded in the single instrument with minimal hassles. However, when held in a taxable account, one is supposed to pay income tax on the calculated interest annually, even though you do not receive the interest in cash.

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