Question of the Week

Zero coupon bonds are frequently cited as a popular investment vehicle for education savings. What are the main characteristics of these instruments?

I. They pay semi-annual interest payments on $1,000 par.
II. They are bought at a deep discount from face and mature for face.
III. They are government guaranteed
IV. They pay no interest

a) II, III, IV
b) I, III
c) II, IV
d) II, III

Answer:

The correct answer is c.

Zero coupon bonds, as the name implies, pay no interest or coupon payments. They are bought (and traded) at a discount from face, and mature for face. The investor’s only return is the difference between the discount purchase price and face at maturity. Although one popular type of zero coupon bond, U.S. Treasury STRIPS, is government guaranteed; this does not apply to all such bonds.

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