Zero-Coupon Bond

A zero-coupon bond (also called a "zero" or "discount bond") makes no periodic interest payments. Instead, it is issued at a significant discount to its face value and the investor receives the full par value at maturity. The difference between the purchase price and par represents the investor's total return, which is effectively compounded over the bond's life. Zero-coupon bonds have the highest duration of any bond with the same maturity, making them extremely sensitive to interest rate changes — a characteristic that makes them popular for speculation on rate movements and for asset-liability matching (e.g., pension funds matching future obligations). U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities) are the most common zero-coupon bonds. Note: even though no cash interest is paid, the IRS requires taxation of the annual "phantom income" (accreted discount) on taxable zero-coupon bonds.