Zero Coupon Bond

Investments

A zero coupon bond is a bond that pays no periodic interest. Instead, it is issued at a deep discount to face value and pays the full face value at maturity. The return is entirely from the difference between purchase price and maturity value.

In detail

Zero coupon bonds (ZCBs) are useful for matching a specific future cash flow need without reinvestment risk. If you need Rs 10L in exactly 10 years, you buy a ZCB with Rs 10L face value maturing in 10 years -- no reinvestment decisions needed.

In India, RBI issues zero coupon bonds and strips of government securities. Some corporate zero coupon bonds are also available. Tax treatment: the difference between purchase price and face value (imputed interest) is taxed annually as income even though no cash is received -- a disadvantage for high tax-bracket investors.

Formula

Price = Face Value / (1 + r)^n r = Required yield, n = Years to maturity Example: Rs 10L face value bond maturing in 10 years at 7% yield: Price = 10,00,000 / (1.07)^10 = Rs 5,08,349 Implicit annual return = (Face value / Price)^(1/n) - 1

Real-life example

🇮🇳 India example

Government of India issues a 10-year zero coupon bond with Rs 1,000 face value priced at Rs 508. If held to maturity: you invested Rs 508 and receive Rs 1,000 -- that is 96.8% absolute return or 7% CAGR over 10 years. No interim interest payments, no reinvestment decisions. Tax is payable annually on the imputed interest even though you receive nothing until maturity.

Frequently asked questions

Are zero coupon bonds available to retail investors in India? ▼

Yes, through RBI Retail Direct (retaildirect.rbi.org.in) which allows purchase of government securities including ZCBs. Corporate ZCBs are available through demat accounts. Some AAA-rated corporate zero coupon bonds offer marginally higher yields than government ZCBs with slightly more credit risk.