Zero coupon bonds and interest rate risk


  1. by AAII Staff
  2. The Zero (Coupon) Hedge
  3. The ABCs of Zero Coupon Bonds | Financial Directions
  4. How Interest Rate Changes Affect the Price of Bonds

by AAII Staff

In a rising interest rate environment, their value is likely to fall more than other bonds. For individuals, zero coupon bonds may serve several investment purposes. By placing funds in a U. Treasury zero, a parent can be assured that the funds will be fully intact to meet this liability.

The Zero (Coupon) Hedge

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.

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  • What Is a Zero-Coupon Bond? - TheStreet Definition.

Zero coupon bonds, also known as zeros, are distinct in that they do not make annual interest payments. The less you pay for a zero coupon bond, the higher the yield.

The ABCs of Zero Coupon Bonds | Financial Directions

Zero coupon bonds are issued by the Treasury Department, corporations and municipalities. The bonds are considered a low-risk investment compared to stocks, commodities and derivatives. Purchase Treasury zero coupon bonds if you want the best chance of having your principal and interest paid at maturity.

Treasury zeros carry a lower interest rate than municipal zero coupon bonds and corporate zero coupon bonds, but they are backed by the full faith and credit of the United States.

How Interest Rate Changes Affect the Price of Bonds

Many investors believe the safety inherent in the bonds makes up for the lower interest rate. The bond interest income is taxed at the federal level and possibly at the state level. Consider corporate zero coupon bonds if you are looking for high interest rates and can stomach the higher risk of default. Many corporate zeros have call provisions that allow the company to call in the bond issue before the maturity date.

  • Price Swings.
  • Zero-Coupon Bond;
  • What Is a Zero-Coupon Bond? - TheStreet Definition.

The interest income after taxes might equal or be less than the interest paid on municipal zeros. Research municipal zero coupon bonds before you buy. Generally, municipalities with low credit ratings have to issue their bonds at a higher interest rate to attract buyers. Also consider how long you want to own the bond. Municipal zeros pay a higher interest rate the longer you hold them, and it can take as little as one year or as long as 40 years for the bond to mature.

Municipal zeros have a lower interest rate than corporate zeros. But their income is exempt from federal and, in some cases, state and local taxes.

Investopedia Video: Zero-Coupon Bond

Contact your bank or broker with your zero coupon bond order.