Zero-coupon bond

A zero-coupon bond is a bond that pays no periodic interest at all, instead it is sold at a discount to its par value and pays the full par value in one lump sum at maturity. The investor's entire return comes from the difference between the discounted purchase price and the par value received at the end, rather than from a stream of coupon payments along the way.

Because there are no coupons to reinvest, a zero-coupon bond has no reinvestment risk before maturity, its full return is locked in at the moment of purchase if held to maturity, unlike a bond that pays regular coupons, whose realized return can end up higher or lower than its stated yield to maturity depending on the rate at which coupons get reinvested. This certainty comes with a tradeoff, a zero-coupon bond also has a duration equal to its full time to maturity, the longest possible duration for a given maturity, which makes its price highly sensitive to changes in interest rates in the years before it matures.

Zero-coupon bonds, sometimes called zeros, are commonly used to fund a future expense with a known date, such as a specific tuition payment or a bond duration matching strategy for a pension liability, since a zero maturing on or near that date delivers a known dollar amount with no coupon income to reinvest along the way. US Treasury zero-coupon bonds, created by separating a regular Treasury note or Treasury bond into its principal and interest components, are one of the more common ways investors access this structure in a very low credit risk form.