Zero Coupon Bond Effective Yield

Bonds may have fixed coupon payments, variable coupon payments, deferred coupon payments and accelerated coupon payments. Its current yield is 4. Certainly you expected to be paid back and possibly with interest.

Defining Coupon Rate

The greater the length until a zero-coupon bond's maturity, the less the investor generally pays for it. Zero-coupon bonds are very common, and most trade on the major exchanges. Corporations, state and local governments, and even the U.

Treasury issue zero-coupon bonds. Corporate zero-coupon bonds tend to be riskier than similar coupon-paying bonds because if the issuer defaults on a zero-coupon bond, the investor has not even received coupon payments -- there is more to lose.

For tax purposes, the IRS maintains that the holder of a zero-coupon bond owes income tax on the ir that has accrued each year, even though the bondholder does not actually receive the cash until maturity.

The IRS calls this imputed interest. Zero-coupon bonds are usually long-term investments ; they often mature in ten or more years. Although the lack of current income provided by zero-coupons bond discourages some investors, others find the securities ideal for meeting long-range financial goals like college tuition.

The deep discount helps the investor grow a small amount of money into a sizeable sum over several years. Because zero-coupon bonds essentially lock the investor into a guaranteed reinvestment rate , purchasing zero-coupon bonds can be most advantageous when interest rates are high.

They are also more advantageous when placed in retirement accounts where they remain tax-sheltered. Some investors also avoid paying taxes on imputed interest by buying municipal zero-coupon bonds, which are usually tax-exempt if the investor lives in the state where the bond was issued. The lack of coupon payments on zero-coupon bonds means their worth is based solely on their current price compared to their face value.

Thus, prices tend to rise faster than the prices of traditional bonds when interest rates are falling, and vice versa. Your next lesson will play in 10 seconds. Add to Add to Add to. Want to watch this again later? How to Calculate Yield to Maturity: How to Calculate the Rate of Return: How to Calculate Risk Premium: How to Calculate Present Value of an Investment: How to Calculate Net Working Capital: How to Calculate Earnings Per Share: How to Calculate Interest Expense: UExcel Introduction to Macroeconomics: The Civil War and Reconstruction.

Praxis Social Studies - Content Knowledge Michael Cozad Michael is a financial planner and has a master's degree in financial services. This lesson will define coupon rate, a term used in fixed-income investing. Defining Coupon Rate Have you ever loaned a friend money? Coupon Rate Formula The formula for coupon rate is as follows: Try it risk-free No obligation, cancel anytime. Want to learn more? Select a subject to preview related courses: To compute the coupon rate, first write down the formula: Lesson Summary Coupon rates are used in the realm of fixed-income investing, mainly when dealing with bonds.

To compute the coupon rate, use the formula: Learning Outcomes Now that you have completed this lesson, you should be ready to: Define coupon rate State the equation for determining the coupon rate of an investment.

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