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- Characteristics of Zero Coupon Municipal Bonds.
Since they do not feature regular interest payments, they are not an income investment, as other bonds are, but should be considered an appreciation investment. It is important to remember, however, that unlike the growth in value of a stock portfolio or mutual fund, the appreciating value of a zero is really a representation of accrued compound interest, and is taxed as such--not as capital gains, which are taxed at lower rates.
There are, however, a variety of tax-free government zeros available. Zeros are also suitable in an IRA or other tax-deferred or tax-free plan since they make no distinction between capital gains and ordinary income for tax purposes. Since zeros are debt instruments, the risk involved depends largely on the credit strength of the issuer.
Zeros backed by government securities like U. Generally, the yield on municipal bonds is lower because the coupon rate paid is normally tax-exempt.
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- Understanding Zero Coupon Bonds - Part One!
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This offsets the lower yield, especially if you are in a high tax bracket. Although short and long term bonds share the same basic structure with the exception of zero-coupon bonds short-term bonds with maturities of less than a year and often less than 90 days behave a little differently. Due to their short duration, they rarely change much in price, and are redeemed at maturity for the full par value in any case.
What is a Zero Coupon Bond?
These are the type of bonds bought and sold by money market funds and are used by corporations and governments to raise cash for immediate needs. Because bonds must be paid off at face value at maturity, they normally carry far less risk than stocks, but also do not offer the opportunity for equity growth. Bonds are the investment of choice for persons seeking safety and income over equity growth as a major part of a portfolio after retirement, for example.
However, bonds are not entirely without risk.
Strategic Considerations of Zero Coupon Securities
If a bond has a low rating or has its rating lowered, it means that the possibility that the issuer may not be able to pay off the bond is higher. Two other factors should be kept in mind. One is that if you buy a bond at a premium and hold it to maturity; you will receive only the par value of the bond, resulting in an equity loss. The other is that some bonds have provisions that allow the issuer to redeem the bond early, which may work to your disadvantage if you bought it at a premium.
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Bonds and their Types
What is a Coupon Bond A coupon bond, also referred to as a bearer bond, is a debt obligation with coupons attached that represent semi-annual interest payments. Compare Investment Accounts.
The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Terms Bearer Instrument A bearer instrument, or bearer bond, is a type of fixed-income security in which no ownership information is recorded and the security is issued in physical form to the purchaser.
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Bearer Bond A bearer bond is a fixed-income instrument that is owned by whoever is holding it, rather than having a registered owner. Coupon A coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value, also referred to as the "coupon rate. Definitive Securities Definitive securities are securities issued in the form of a paper certificate as opposed to book-entry securities.
Registered Bond A registered bond is a bond which has its owner registered with the bond's issuer. The owner's name and contact information is recorded and kept on file with the company, allowing it to pay the bond's coupon payment to the appropriate person. Bearer Form A bearer form is a security not registered in the issuing corporation's books, but which is payable to its bearer, that is, the person possessing it. Partner Links.
The Zero Coupon Bond: Pricing and Charactertistics
Related Articles. Fixed Income Essentials What is the difference between a zero-coupon bond and a regular bond? Interest Rates What is accrued interest, and why do I have to pay it when I buy a bond?