Zero-Coupon Bond
A bond that pays no periodic interest and is issued at a deep discount to face value.
What is Zero-Coupon Bond?
A zero-coupon bond pays no periodic interest (coupons). Instead, it is issued at a significant discount to its face value and redeems at full face value at maturity — the difference representing the investor's entire return. Zero-coupon bonds have the longest duration relative to maturity of any bond type, making them highly sensitive to interest rate changes. They are commonly used in retirement planning and by pension funds to match future liabilities. US Treasury STRIPS are a prominent example.
Example
A 10-year zero-coupon Treasury STRIP with a face value of $1,000 might be purchased today for $613. The $387 appreciation over 10 years represents an annualized return of approximately 5% with no reinvestment risk.
Source: US Treasury — STRIPS