Investing in zero coupon bonds is beneficial in the long run.
Zero Coupan Bonds: Zero coupon bonds are also called mostly ‘zero’ as no coupon (interest) is paid on these bonds. Nevertheless, investing in zero coupon bonds is considered attractive. The biggest reason for this is that it always issues at a discount. This means that to invest in it, investors always have to pay at least less than the face value. Before maturity, these bonds are traded at a discount, never at a premium.
Long-term investors such as pension funds and insurance companies can lock in for any rate of return by purchasing zero coupon bonds and holding them till maturity. Zero coupon bonds do not carry reinvestment risk. A plain vanilla bond can be considered as a portfolio of zero coupon bonds that mature every six months.
No reinvestment risk
Investors have to wait till maturity to buy zero coupon bonds. After maturity, he finally gets face value. The difference between the bond and face value received at the discounted price is the return for the investor. In other words, the zero coupon bond pays the investor the principal amount he invested at maturity. Apart from this, the investor also gets interest and this interest also gets interest. Thus, there is no reinvestment risk in investing in zero coupon bonds as opposed to plain vinyl bonds.
Beneficial investment in the long run
Zero coupon bonds are very beneficial for investors who are afraid of market fluctuations. Investing in this bond is better for investors who are looking for long-term investment options and want them to get returns in the form of lumps. For example, if an investor wants lump sum money for the wedding or marriage of children in future, then investing in zero coupon bonds can be a good option.
Discounted price is fixed at half yearly rate
Zero coupon yields are a single cash flow and can be priced on an annual or half yearly interest rate basis. Usually the discount value of face value of such type of bond is fixed at half yearly rate as investors have the option to invest in coupon paying bonds and zero coupon bonds. Of this, the discount rate of coupon paying bonds is fixed on a half-yearly basis, so usually the discount price of zero coupon bonds is also fixed at half-yearly rate so that investors can compare better.
Source: www.financialexpress.com
