Zero-Coupon Bond

A bond that pays no periodic interest — all return comes from price appreciation to par.

A zero-coupon bond (or 'zero') pays no coupons—all return comes from buying below par and receiving par at maturity. For example, a 10-year zero might be issued at $600 and mature at $1,000, implying a yield of ~5.2% annually. Zeros are highly sensitive to interest rates (high duration) because there are no interim coupons to cushion price volatility. Uses: Tax-deferred accounts (to avoid phantom income tax on imputed interest), liability matching (pension funds), and duration management. Examples: US Treasury STRIPS (Separate Trading of Registered Interest and Principal Securities) are zeros created by stripping coupons from regular Treasuries. Corporate zeros are less common due to unfavorable tax treatment.

Formula

P = \frac{\text{Par}}{(1 + y)^T}