Bonds provide a predictable and regular flow of income. Moreover, they add an element of stability to any portfolio by diversifying it. While most bonds offer interest once/twice a year to maintain the fixed income provided, there are certain types that do not make coupon payments. These are known as zero-coupon bonds.

Zero-coupon bonds are debt security instruments that allow investors to earn returns from differential rates of bonds at the time of sale. This makes zero-coupon securities one of the preferred investment avenues for those with a longer horizon and in pursuit of long-term gains.

Read on to know more about zero coupon bonds’ meaning, how they work, and steps to purchase them.

A coupon in bonds means the interest payable by the issuer of a bond. Here, the zero-coupon bond is an instrument that offers no interest. Investors can buy these stocks at a discounted rate as compared to the face value. 

At the time of the bond’s maturity, the issuer pays the investor its face value. Hence, individuals can earn returns based on the difference in the value of the bond at the time of buying and selling it.

You can calculate your zero-coupon bond’s price using the Yield-to-Maturity (YTM) formula. Here is the formula for calculating the prices of these bonds:

Current Value of a Zero-Coupon Bond = (Face value /(1+YTM)^n) – 1

Here,

Face value: Price at which the bond is sold

n: Tenor’s duration in years  

To find the value for ‘YTM’:

Yield to Maturity = [Annual Interest + {(FV-Price)/Maturity}] / [(FV+Price)/2]

Where,

Price: Current market value

FV: Face value

Maturity: Number of years until the bond matures

To buy zero-coupon bonds, you need to follow these simple steps:

• Own an active Demat account with a registered depository participant

• Choose the issuer from whom you wish to purchase zero-coupon bonds

• Place an order for your preferred bond by making payment for it

Once the transaction is successful, the bonds will reflect in your Demat account

For investors with a fixed long-term goal, zero-coupon bonds may be a viable instrument. However, if your primary financial objective is wealth creation in the short term, you may find other market-linked investment tools more attractive.

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