Zero-Coupon Bonds: Features, Pricing and Taxation
Zero-coupon bonds, popular with HNIs and family offices for tax efficiency and lump-sum payout, saw high demand in late 2024, but recent monetary and market shifts cooled investor interest.
Key facts
- A ZCB (also an accrual bond) is a debt security with no coupons.
- Issuers: governments, corporations and financial institutions, which may strip coupons and repackage bonds.
- Example: buy at ₹6,855, receive ₹20,000 at maturity; implied yield 5.5% compounded semiannually.
- Pricing inputs: maturity value (M), required yield (r) and years to maturity (n).
Taxation
- Imputed interest is taxed every year though no cash arrives until maturity, as ordinary income.
- Ways to avoid it: municipal ZCBs (often exempt), tax-deferred or exempt accounts, tax-exempt corporate ZCBs.
Advantages and disadvantages
- Pros: predictable lump sum, no reinvestment risk, suits long-term goals, gains in falling-rate phases.
- Cons: no interim income, high duration and volatility, tax on imputed interest, limited secondary-market liquidity.
| Feature | Zero-coupon | Regular bond |
|---|---|---|
| Interest | Imputed, not paid | Paid periodically |
| Price | Deep discount | Near face value |
| Return | Par minus price at maturity | Coupons plus principal |
| Volatility | Higher | Lower |
| Tax | On imputed interest yearly | On coupons received |
Exam angle
- Alternate name: accrual bond.
- Related terms: par value, imputed interest, duration.