Treasury Zero Coupon Bond

U.S. government zero coupon bonds are bonds that do not pay any interest during the life of the bonds. However, the advantage of these bonds is that investors buy zero coupon bonds at a discount from their face value, which is the amount a bond will be worth when it matures or comes due. When a zero coupon bond reaches its end of term (matures), the bond holder will receive one lump sum equal to the initial payment plus the interest.

The maturity dates on zero coupon bonds are usually long-term, and many don't mature for ten, fifteen, or more years. These long-term maturity dates allow an investor to plan for a long-range goal, such as retirement or paying for a child's college education. Because of the discount, an investor can put up a small amount of money that grows over many years.

The prices of zero coupon bonds fluctuate more than other types of bonds because their full value is not received until they mature. No payments are given on zero coupon bonds until they mature, but the investors may still have to pay federal, state, and local income tax on the interest that the bond accrues each year. Instead of making regular interest payments, the value of the bond increases each year because the interest accrues until the zero coupon bond matures at face value, but only if the investor holds the bond until maturity.

If a zero coupon bond is sold before maturity, the investor might gain or lose because the market price could be more or less than the purchase price due to the fluctuation in the amount of interest that has accrued between the time the security was purchased and the sale date.

The current value of a zero coupon bond before maturity will go up or down according to fluctuations in the interest rate. The bond value is inversely related to interest rates because as interest rates rise, the value of the bond will fall and as interest rates fall, the value of the bond will rise. However, if the bond is held until maturity, the return is backed in full by the U.S. Government.