星期一 Nov 27 2023 06:08
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Zero-coupon bonds are a unique type of bond that does not pay interest periodically like traditional coupon bonds. Instead, zero-coupon bonds are sold at a deep discount to their face value and gradually increase in value until reaching full face value at maturity. This makes zero-coupons an attractive fixed-income investment option for traders and investors.
Learn about zero-coupon bonds in this article. Familiarise with their benefits, associated risks, significance to traders, and platforms to trade these bonds.
Zero-coupon bonds work differently than regular bonds that make periodic interest payments, known as coupon payments. Here is a comprehensive overview of how zero-coupon bonds function:
There are a few main types of zero-coupon bonds available in the marketplace:
Given the US government's perfect credit rating and exceptionally low default risk, it is considered one of the safest investments. STRIPS stands for Separate Trading of Registered Interest and Principal of Securities.
They are created by separating traditional Treasury coupon bonds into individual principal and interest components that can be traded separately as zero-coupon bonds.
It was issued by federal government agencies and GSEs (government-sponsored enterprises) like Fannie Mae and Freddie Mac. It is also considered very safe with implied government backing.
They were issued by corporations in need of financing. Credit risk is higher than government zeros, but yields are higher to compensate investors. Credit ratings allow for assessing corporate default risk.
State/local governments and municipalities issued it for public works projects. Offer tax-exempt interest income. Credit risk varies based on the municipal issuer's financial standing.
Across all sectors, the zero-coupon bonds share the same underlying structure of a deeply discounted price, no periodic payments, and increasing value over time. The higher the credit rating and financial strength of the issuing entity, the lower the bond's default risk. Government-backed zeros represent the least risky options.
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There are several advantages to zero-coupon bonds as an investment:
The highest-yielding zero-coupon bonds typically have longer-term maturities and higher credit risk exposure. Government-issued zero-coupon bonds are considered the safest but have lower yields. Ultimately, zero-coupon bonds across sectors share the same basic advantageous features.
While zero-coupon bonds do offer unique benefits, there are also some risks to consider:
The level of risk mainly depends on the creditworthiness and financial health of the issuing entity. Government-backed zero-coupon bonds carry virtually no risk of default. Corporate zeros have higher credit risk that rises the longer the maturity date.
The unique deferred interest structure of zero-coupon bonds makes them suitable for certain financial planning purposes:
Retirement income planning - Zero-coupon bonds can provide guaranteed income in retirement if the maturity date aligns with when funds are needed. Investors can ladder bonds with sequential maturity dates to create a steady retirement income stream.
Large purchases - Zero coupons can fund large future expenses like buying a house, boat, or other major purchases on a predetermined timeline.
Emergency fund - Having zero-coupon bonds on hand provides funds that can be liquidated if an immediate need for cash arises unexpectedly.
Deferred liabilities - Issuing entities use zeros to raise capital now while delaying interest costs until bonds mature. This is useful for governments, municipalities, and corporations with fluctuating cash flows.
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Zero-coupon bonds can play a valuable role in an investment portfolio and financial plan when used properly. Their unique attributes can provide portfolio diversification, income planning, emergency reserves, and tax optimization.
However, zeros may not be ideal for investors who prefer regular income streams or want to avoid inflation risk. As with any investment, there are pros and cons to weigh based on individual circumstances and goals.
The unique structure of zero-coupon bonds also leads to some specific tax considerations:
Consulting a tax professional is advised when investing substantially in zero-coupon bonds to ensure accurate tax reporting and optimal use of their tax-deferred features.
For investors, there are several options to purchase existing zero-coupon bonds:
The majority of zero-coupon bond trading occurs in over-the-counter secondary markets between investors. There are also select occasions where corporates and municipalities issue new zero-coupon bonds to raise capital, providing additional primary market purchasing opportunities.
Zero-coupon bonds offer a compelling investment proposition that combines above-average yields, financial planning utility, tax advantages, and interest compounding. While they come with some inherent risks like any bond, their deferred interest structure makes them a singular fixed-income vehicle suited for specific investor objectives.
Unlike regular bonds, zero-coupon bonds reward patient long-term investors who hold them until maturity.
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When considering “CFD zero-coupon bonds” for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”