**Key Points:**

- The word Coupon represents “Interest.”
- Interest is not paid for the invested amount.
- The difference between discounted purchase price and face value of the bond is the income of the investor.
- The earnings of Zero Coupon Bond are higher than the Regular Bond’s earnings.
- The maturity period of this bond is longer than Regular bond.

**What is Zero-Coupon Bond?**:

Zero-Coupon Bond is a debt security where the investors will not get any interest against his invested money but he will get a big discount while purchasing the bond. At the time of maturity, when the investor will go to the liquidation he will receive the full face value amount. Normally, a zero coupon bond has a higher return than the regular bond with the same maturity.

Hence, **Zero Coupon bond is the bond which has a zero interest and the investor purchase it with lower price than its face value, and reimbursed full face value amount at the time of maturity.**

There are different types of Zero Coupon bond. From the start, some company is issued their bond as zero-coupon instruments. Again, some company transforms into zero coupon instruments after a financial institution divest of its interest coupon, and repackages as zero-coupon bonds.

Zero-Coupon bond also known as an accrual bond, and the word coupon represents interest.

**Pricing Formula of Zero – Coupon Bonds:**

Pricing of bond is important to determine how much amount an investor will be paid at the time of purchasing the bonds. As Zero-Coupon bond purchases with a discount, hence it is important, how much discount to be determined for ascertaining the price. However, to calculate the price of a zero-coupon bond, following formula to be used:

**Price of Bond = Face Value/(1+r) **n

Where:

**Face value** is the future (maturity) value of the bond.

**r** is the required rate of return/interest

**n** is the numbers of years up to maturity.

This formula uses when the interest is compounded annually. But practically it can be paid semiannually, when the formula will be:

**Price of Bond = Face Value/(1+r/2) nx2**

The difference between annually and semi-annually formula is:

In semiannually, the ‘**r’** is divided by two and **‘n’ **is multiplied by two.

**Examples of a Zero-Coupon Bonds**:

**Example -1:** **Annual Compounding**

Robi is intending to purchase a zero coupon bond with a face value of $1,000 and 5 years to maturity. The interest rate on the bond is 7% compounded annually. What price Robi will pay for the bond today?

Price of bond = $1,000/(1+.07)5 = $713.27

Hence, the price that Robi will pay for the bond today is $713.27.

**Example 2: Semi-annual Compounding**

Robi is intending to purchase a zero coupon bond with a face value of $1,000 and 5 years to maturity. The interest rate on the bond is 7% compounded semi-annually. What price Robi will pay for the bond today?

Price of bond = $1,000 / (1+0.07/2)^{5*2} = $709.22

The price that Robi will pay for the bond today is **$**709.22