Zero-Coupon Bond
A zero-coupon bond pays no regular interest. It is sold below face value and repaid at full face value at maturity; the difference is the investor’s return. Its price is very sensitive to interest-rate changes.
Most bonds pay interest every six months. A zero-coupon bond pays nothing until the end: you buy it at a discount and receive the full face value when it matures. That simplicity makes zeros useful for saving towards a known date — and makes their prices move sharply when interest rates change. This entry explains how zeros are priced, why they are so rate-sensitive, and what to watch out for.
- Category
- Bonds and Interest Rates
- Reading time
- 4 min
- Also called
- Zero, Discount bond, STRIPS
- Updated
Zero-coupon bonds in plain words
Zero-coupon bonds do not pay interest during their life. Instead you buy them at a deep discount to face value and receive the face value when they mature.1 The difference is your return.
Their maturities are often long — ten, fifteen or more years — which lets investors plan for a future cash need.1 See Treasury Bills, Notes and Bonds.
How zero-coupon bonds work, step by step
Face value
The amount paid at maturity, e.g. $1,000.
Price today
Face value ÷ (1 + yield)^years, for annual compounding.
Return
Face value − price, earned over the life of the bond.
Yield
The rate that turns today’s price into face value at maturity. See Yield to Maturity.
Rate sensitivity
All value arrives at the end, so prices react strongly to rate changes. See Duration.
Taxes
In some countries the yearly accrued gain is taxed even though no cash is paid.
Worked examples
Example 1 — Pricing a zero
PricingA 10-year zero with $1,000 face value; market yield 4% (annual compounding).
| Price | $1,000 ÷ 1.04¹⁰ ≈ $676 |
| Return at maturity | $1,000 − $676 = $324 |
All of the return comes from the price rising to face value.
Example 2 — Rate sensitivity
Rate riskThe yield on the same 10-year zero rises from 4% to 5%.
| New price | $1,000 ÷ 1.05¹⁰ ≈ $614 |
| Price change | ≈ −9% |
A 1-point rise in yield cut the price by about 9%. Fixed-rate bond prices fall when market rates rise.2
Example 3 — Saving for a known date
PlanningA parent needs $20,000 in 15 years and buys zeros maturing then.
| Cash at maturity | $20,000 (if the issuer pays) |
Held to maturity, price swings along the way do not change the final amount.
Zero-coupon vs. coupon bond
| Aspect | Zero-coupon | Coupon bond |
|---|---|---|
| Interest payments | None until maturity | Regular coupons |
| Price | Deep discount | Near face value |
| Rate sensitivity | Higher | Lower for the same maturity |
| Reinvestment risk | None | Coupons must be reinvested |
Where zeros are used
Known future needs
Education, retirement or liabilities on a fixed date.
Rate bets
Their sensitivity makes them a strong bet on falling rates. See Interest Rate.
Portfolio matching
Institutions match zeros to future payments.
Building blocks
Coupon bonds can be split into separate zeros.
Advantages and disadvantages
Advantages
- Known payout at a known date.
- No reinvestment risk on coupons.
- Bought at a discount, so less money is needed up front.
Disadvantages
- Very sensitive to interest-rate changes.
- No income along the way.
- Possible tax on accrued gains before any cash arrives.
- Full exposure to the issuer’s default at maturity.
Going deeper
Read as far as you need. Each level builds on the one before it.
The discount is the interest
Beginner
You earn your return by buying below face value, not through coupon payments.
Duration equals maturity
Intermediate
For a zero, the duration — the average timing of payments — equals its maturity, which is why its price is so sensitive. See Duration.
Default risk
Advanced
A default is a failure to pay principal or interest when due.3 With a zero, all of the payment comes at the end, so credit quality matters a great deal. See Credit Spread.
Common mistakes
Underestimating price swings
Long zeros can fall sharply when rates rise.
Forgetting taxes on accrued gains
Check local tax treatment.
Selling before maturity unintentionally
Only the maturity value is certain.
Ignoring issuer quality
Everything depends on the final payment.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Zeros pay no coupons; you buy at a discount and receive face value.
- Price = face value ÷ (1 + yield)^years.
- They are very sensitive to interest-rate changes.
- No reinvestment risk, but full default exposure at maturity.
- Useful for saving towards a known date.
Frequently asked questions
Do zero-coupon bonds pay interest?
Can I lose money on a zero-coupon bond?
Why buy a zero instead of a normal bond?
Further learning
- Yield to Maturity
How bond returns are measured.
- Duration
Why zeros swing so much.
- Treasury Bills, Notes and Bonds
Government bonds and their maturities.
- Interest Rate
What drives zero prices.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Investor.gov (SEC). Zero Coupon Bond (glossary) (opens in a new tab) Checked .
- Investor.gov (SEC). Investor Bulletin: Fixed Income Investments — When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall (opens in a new tab) Checked .
- Investor.gov (SEC). Default (glossary) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.