Zero-coupon Bonds

There are various types of bonds in the bond market. A special type is one that is called zero-coupon bonds. This is a long term bond which does not pay interest during its life time. Upon maturity, zero coupon bonds are paid the full face value in a single payment plus the accrued interest. Sometimes these bonds have a life of up to 20 or even 30 years. Interested investors can purchase them from the government or government agencies at discounted rates. A notable feature about zero coupon bonds is that their prices fluctuate more often than ordinary bonds. Another exciting feature about these bonds is that even though they don’t pay interest during their entire life, their holder is charged tax on a virtual interest that invisibly accrues on the bond each year. The tax is paid to the bond issuer. For instance a zero coupon holder from a local government authority will pay annual tax for the virtual interest accrued to the local government authority. This is the major difference with other types of bonds called Series EE savings bonds which is totally exempted from tax. You can avoid paying the tax on bonds by buying tax free zero coupon bonds like Series EE savings bonds from the local states where you reside. Another major difference is that Series EE savings bonds can be redeemed any time from six months. The major advantage of Zero coupon bonds is that you can obtain them at heavily discounted rates which range from anything between 60% and 80% of their nominal value. Some issuers for one reason or another can call the zero coupon bonds before maturity. In this case, holders get a lump sum payment of their interest calculated against the period they have held the bonds. Before then however, the holder will be paying tax on the accrued interest until the issuer calls them. It is interesting to note that most world credit bureaus award credit scores on the zero coupon bonds. So you can actually use the zero coupon bonds to improve your credit rating. Zero coupon bonds are very suitable for planning for foreseeable major financial obligations. For instance, a parent who is planning to take a child to the university in 15 years can use the zero coupon bonds to achieve the goal. A young man who will retire from formal employment in 30 years too can use zero coupon bonds as an investment plan.