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Types of Bonds

What are Zero Coupon Bonds?

While most municipal bonds provide semiannual interest payments, zero coupon bonds, as their name suggests, have no “coupon,” or periodic interest payments. Instead, the investor receives one payment—at maturity—that is equal to the principal invested plus the interest earned, compounded semiannually, at a stated yield.

Zero coupon bonds are sold at a substantial discount from the face amount. For example, a bond with a face amount of $20,000, maturing in 20 years with a 5.5% coupon, may be purchased for roughly $6,757. At the end of the 20 years, the investor will receive $20,000. The difference between $20,000 and $6,757 represents the interest that compounds automatically until the bond matures (see example below).

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Example:  A $6,757.04 purchase of zero coupon municipal bonds on January 1, 2008, due January 1, 2028, with a 5.5% original-issue yield and semi-annual compounding will be redeemed in 20 years for $20,000. The purchase will accrete as shown below on January 1 of each of the following years:

2013 $ 8,862.88
2018 $11,625.01
2023 $15,247.96
2028 $20,000.00

 

 

All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.