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Zero coupon bonds or zeros don?t make regular interest payments like other
bonds do. You receive all the interest in one lump sum when the bond
matures. You purchase the bond at a deep discount and redeem it a full face
value when it matures. The difference is the interest that has accumulated
over the years. The normal income is packaged and sold to investors who need
a reliable cash flow and the principal becomes a zero coupon bond.
Various Maturities
Zero coupon bonds generally come in maturities from one to forty years. The
U.S. Treasury issues are the most popular ones, along with municipalities
and corporations.
Here are some general characteristics of zero coupon bonds:
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Issued at deep discount and redeemed at full
face value
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Some issuers may call zeros before maturity
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You must pay tax on interest annually even
though you don?t receive it until maturity
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Zero coupon bonds are more volatile than regular
bonds
Municipalities and corporations also issue zero
coupon bonds. They have the same basic feature of being sold at a deep
discount and redeemed in the future at full face value.
However, some of these issues may have call features allowing the issuer to
redeem them before maturity. Be sure a check what if any those provisions
are before you invest.Municipal zero coupon bonds are free from federal
income tax like regular municipal bonds.
The major credit agencies rate most zero coupon bonds for credit worthiness.
This rating can change during the life of the bond, which can affect the
price.
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