20 Investments: Zero-Coupon Securities
AAA
  1. 20 Investments: Introduction
  2. 20 Investments: American Depository Receipt (ADR)
  3. 20 Investments: Annuity
  4. 20 Investments: Closed-End Investment Fund
  5. 20 Investments: Collectibles
  6. 20 Investments: Common Stock
  7. 20 Investments: Convertible Security
  8. 20 Investments: Corporate Bond
  9. 20 Investments: Futures Contract
  10. 20 Investments: Life Insurance
  11. 20 Investments: The Money Market
  12. 20 Investments: Mortgage-Backed Securities
  13. 20 Investments: Municipal Bonds
  14. 20 Investments: Mutual Funds
  15. 20 Investments: Options (Stocks)
  16. 20 Investments: Preferred Stock
  17. 20 Investments: Real Estate & Property
  18. 20 Investments: Real Estate Investment Trusts (REITs)
  19. 20 Investments: Treasuries
  20. 20 Investments: Unit Investment Trusts (UITs)
  21. 20 Investments: Zero-Coupon Securities
  22. 20 Investments: Conclusion
20 Investments: Zero-Coupon Securities

20 Investments: Zero-Coupon Securities

What Is It?
A zero-coupon security, or "stripped bond", is basically a regular coupon-paying bond without the coupons. The process of "stripping" or "zeroing" a bond is usually done by a brokerage or a bank. The bank or broker stripping the bonds then registers and trades these zeros as individual securities.

Once the bonds are stripped, there are two parts: the principal and the coupons. The interest payments are known as "coupons", and the final payment at maturity is known as the "residual" since it is what is left over after the coupons are stripped off. Both coupons and residuals are bundled and referred to as zero-coupon bonds or "zeros".

You can think of a zero-coupon security just like a T-bill. Basically, you pay a certain amount right now in exchange for the par value of the security at a future date, usually $1,000. For example, you might pay $800 for a zero-coupon bond today and in five years you will receive the par value of $1,000. The longer the time to maturity, the cheaper you can buy the bond for. This predictability also makes zeros popular - when you buy the security, the yield is essentially locked in.

Objectives and Risks
The basic objective of a zero-coupon security is "buy low, sell high". You purchase the bond for a sum of money, and once it reaches maturity you will be paid an even larger sum of money. When interest rates are low, the price of the zero will be higher. The best time to buy a zero is when interest rates are high because the bond will be at a deeper discount.

The one major problem with zeros is that the annual accumulated return is actually considered to be income, and while you don't actually collect that interest until the bond reaches maturity, you still have to pay income tax on it. In other words, the gains on a zero are not treated as capital gains, instead they are considered to be interest.

How To Buy or Sell It
Zero-coupon securities can be bought through most full service or discount brokers, commercial banks, and some other financial intermediaries.

Strengths

  • Zeros can be bought at huge discounts.
  • Once you buy a zero-coupon security, you essentially lock in the yield to maturity.

  • Weaknesses
  • If the company issuing the zero goes bankrupt or defaults, then you have everything to lose. Whereas, with a regular coupon bond, you may have at least gotten some interest payments out of the investment.
  • Interest earned on the zero-coupon bond is taxed as income (a higher rate) rather than capital gains.

  • Three Main Uses
  • Capital Appreciation
  • Tax-Deferred Savings
  • Predictability
  • 20 Investments: Conclusion

    1. 20 Investments: Introduction
    2. 20 Investments: American Depository Receipt (ADR)
    3. 20 Investments: Annuity
    4. 20 Investments: Closed-End Investment Fund
    5. 20 Investments: Collectibles
    6. 20 Investments: Common Stock
    7. 20 Investments: Convertible Security
    8. 20 Investments: Corporate Bond
    9. 20 Investments: Futures Contract
    10. 20 Investments: Life Insurance
    11. 20 Investments: The Money Market
    12. 20 Investments: Mortgage-Backed Securities
    13. 20 Investments: Municipal Bonds
    14. 20 Investments: Mutual Funds
    15. 20 Investments: Options (Stocks)
    16. 20 Investments: Preferred Stock
    17. 20 Investments: Real Estate & Property
    18. 20 Investments: Real Estate Investment Trusts (REITs)
    19. 20 Investments: Treasuries
    20. 20 Investments: Unit Investment Trusts (UITs)
    21. 20 Investments: Zero-Coupon Securities
    22. 20 Investments: Conclusion
    20 Investments: Zero-Coupon Securities
    RELATED TERMS
    1. Business Broker

      A professional who specializes in the purchase and sale of companies. ...
    2. Return On Equity - ROE

      The amount of net income returned as a percentage of shareholders ...
    3. Forbearance

      A temporary postponement of mortgage payments.
    4. Warranty of Title

      A guarantee by a seller to a buyer that the seller has the right ...
    5. Warranty Deed

      A type of document that may be used to legally transfer property. ...
    6. Foreign remittance

    1. I am in my mid thirties and have nothing invested for retirement. Is it too late ...

      It is never too late to start saving for retirement. Even starting at age 35 means you will have more than 30 years to save.The ...
    2. What is the difference between preferred stock and common stock?

      Preferred and common stocks are different in two key aspects. First, preferred stockholders have a greater claim to a company's ...
    3. Is it wise to put an IRA account into a fixed or variable annuity?

      The answer to this depends on an individual's investment goals, requirements and risk tolerance. During the 1990s, the majority ...
    4. Why do some preferred stocks have a higher yield than common stocks?

      Before we answer this question, let's just take a quick review of what a stock's yield is actually measuring.The yield is ...
    comments powered by Disqus
    Related Tutorials
    1. Investing For Safety and Income Tutorial
      Bonds & Fixed Income

      Investing For Safety and Income Tutorial

    2. American Depositary Receipt Basics
      Economics

      American Depositary Receipt Basics

    3. Certificates Of Deposit
      Bonds & Fixed Income

      Certificates Of Deposit

    4. Binary Options Tutorial
      Options & Futures

      Binary Options Tutorial

    5. Top ETFs And What They Track: A Tutorial
      Mutual Funds & ETFs

      Top ETFs And What They Track: A Tutorial

    Trading Center