What is a 'Zero Coupon Swap'
A zero coupon swap is an exchange of income streams in which the stream of floating interestrate payments is made periodically, as it would be in a plain vanilla swap, but the stream of fixedrate payments is made as one lumpsum payment when the swap reaches maturity instead of periodically over the life of the swap.
BREAKING DOWN 'Zero Coupon Swap'
A zero coupon swap is a derivative contract entered into by two parties. One party makes floating payments which changes according to the future publication of the interest rate index (e.g. LIBOR, EURIBOR, etc.) upon which the rate is benchmarked. The other party makes payments to the other based on an agreed fixed interest rate. The fixed interest rate is tied to a zero coupon bond  a bond that pays no interest for the life of the bond, but is expected to make one single payment at maturity. In effect, the amount of the fixedrate payment is based on the swap's zero coupon rate. The bondholder on the end of the fixed leg of a zero coupon swap is responsible for making one payment at maturity, while the party on the end of the floating leg must make periodic payments over the contract life of the swap. However, zero coupon swaps can be structured so that both floating and fixed rate payments are paid as a lump sum.
Since there’s a mismatch on the frequency of payments, the floating party is exposed to a substantial level of default risk. The counterparty that does not receive payment until the end of the agreement incurs a greater credit risk than it would with a plain vanilla swap in which both fixed and floating interest rate payments are agreed to be paid on certain dates over time.
Valuing a zero coupon swap involves determining the present value of the cash flows using a spot rate (or zero coupon rate). The spot rate is an interest rate that applies to a discount bond that pays no coupon and produces just one cash flow at maturity date. The present value of each fixed and floating leg will be determined separately and summed together. Since the fixed rate payments are known ahead of time, calculating the present value of this leg is straightforward. To derive the present value of cash flows from the floating rate leg, the implied forward rate must be calculated first. The forward rates are usually implied from spot rates. The spot rates are derived from a spot curve which is built from bootstrapping, a technique that shows a sequence of spot (or zerocoupon) rates that are consistent with the prices and yields on coupon bonds.
Variations of the zero coupon swap exist to meet different investment needs. A reverse zero coupon swap pays the fixed lumpsum payment upfront when the contract is initiated, reducing credit risk for the payfloating party. Under an exchangeable zero coupon swap, the party scheduled to receive a fixed sum at the maturity date can use an embedded option to turn the lumpsum payment into a series of fixed payments. The floating payer will benefit from this structure if volatility declines and interest rates are relatively stable to declining. It is also possible for the floatingrate payments to be paid as a lump sum in a zerocoupon swap under an exchangeable zero coupon swap.

Swap Rate
The rate of the fixed portion of a swap as determined by its ... 
Swap Curve
A swap curve identifies the relationship between swap rates at ... 
Swap Spread
A swap spread is the difference between the fixed component of ... 
Swap
A swap is a derivative contract through which two parties exchange ... 
Currency Swap
A swap that involves the exchange of principal and interest in ... 
Constant Maturity Swap  CMS
In a constant maturity swap, the floating interest portion resets ...

Trading
How Are Interest Rate Swaps Valued?
When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps. 
Managing Wealth
An InDepth Look at The Swap Market
The swap market plays an important role in the global financial marketplace; find out what you need to know about it. 
Trading
Different Types of Swaps
Investopedia explores the most common types of swap contracts. 
Investing
What's an Interest Rate Swap?
An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount. 
Trading
Hedging With Currency Swaps
The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it. 
Investing
The Advantages Of Bond Swapping
This technique can add diversity to your portfolio and lower your taxes. Find out how. 
Investing
CFTC Probes Banks' Use of Interest Rate Swaps
U.S. regulators are probing banks' trading and clearing of interest rate swaps, which played a central role in the 2008 financial crisis 
Investing
Comparing Yield To Maturity And The Coupon Rate
Investors base investing decisions and strategies on yield to maturity more so than coupon rates. 
Investing
The Pros & Cons Of Using Coupons For Your Business
Coupons can drive business to your store – you just need to make sure it's profitable business. Here are strategies that work.

What are interest rate swaps on the OTC market?
Learn about interest rate swaps and how they are traded over the counter, and understand the impact of DoddFrank on swaps ... Read Answer >> 
How are swap agreements financed?
Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >> 
How do companies benefit from interest rate and currency swaps?
An interest rate swap involves the exchange of cash flows between two parties based on interest payments for a particular ... Read Answer >> 
Can bond traders trade on interest rate swaps?
Read about interest rate swaps and why these transactions are performed by institutional actors in the bond market, not individual ... Read Answer >> 
How can a company hedge with currency swaps?
Read a brief overview of how currency swap exchanges function, why a swap bank is necessary, and how the parties involved ... Read Answer >>