Zero coupon bond

In finance, a zero-coupon bond is an obligation that does not entitle to coupon detachment, hence the term. The buyer subscribes the bond at a price lower than its face value, which is paid at the end of the contract. The zero-coupon is usually indexed to inflation. It is a form widely used by government bonds, especially those of the United States, T-bills;

Contents

Objectives

Among the bonds, only the zero-coupon makes it possible to really eliminate any interest rate risk between two dates. A conventional fixed rate bond (denominated in English as plain vanilla bond) actually generates as many additional rate risks as it has intermediate financial flows: the reinvestment rate of each coupon between its date of payment and the final repayment date is, in fact, unknown, even if it is implicit in the price of the bond.

By buying a conventional fixed-rate bond, one buys the full rate curve from now until the bond's repayment date, and the reinvestment rates are are not the ones implied originally.

Only a zero-coupon instrument has a duration equal to its average life.

Only a zero-coupon instrument will have systematically, at the end of its life, an effective rate of return equal to its original actuarial rate.

Categories

There are two kinds of zero-coupon bonds:

  • those originally issued as such;
  • those resulting from the break-up of other obligation and are therefore a certificate of financial flows. There are two kinds, depending on the nature of the original flow:
    • coupon certificates;
    • the certificates of principal.

The dismemberment of government bonds has been introduced:

  • in 1982 in Canada
  • in 1985 in the United States by the US Treasury,
  • in 1991 in Europe by the French Treasury.
Rate this post:
Loading...