Zero coupon bond

A zero coupon bond is one which does not pay interest. It is instead issued at a discount to its face value (which is what the holder will receive at maturity). Instead of interest payments, the holder receives a capital gain at maturity.

The duration of a zero coupon bond is clearly longer than that of an otherwise similar bond that pays interest and it will be more sensitive to changes in interest rates. This is best understood by looking at how the present values of a zero coupon and an interest paying bond will be affected by changes in interest rates.

The UK, and many other countries, treat some of the capital gain on a zero coupon bond as income for tax purposes.

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