Definition: A bond that doesn't pay interest but is sold at a deep discount. The investor profits from the bond going up in value (kind of like a stock).
Characteristics: Zero coupon bonds are sometimes issued as such or sometimes they're actual interest-bearing bonds that have been stripped of their interest and repackaged as no-interest bonds by financial institutions. They are sold at a deep discount and are usually known to be quite volatile.
Downside: Even though zero-coupon bonds don't pay interest, the investor is responsible for paying taxes on them each year based on what they would have made.