Finance

Zero Coupon Bond Vs Regular Coupon Bond

Zero-Coupon Bond Vs Regular Coupon Bond

Bonds having similar characteristics to the Fixed Deposit in saving banks account. Bonds are lending money to the bond issuers or bond borrower. They are similar to Fixed Deposits, however, the FD’s are lending money to banks. The significant difference between the bonds and fixed deposits is, the bondholder can sell the bond before the maturity of the bond to another investor who is ready to purchase the bond. In return, the bondholder or investor receives an interest in regular intervals till the maturity period and also principle on the maturity date of the bond. Bonds are issued by corporate companies and government Entities. The difference of Zero Coupon Bond Vs Regular Coupon Bond can be understood as under.

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While purchasing bond we have to understand certain Terminology or Components of Bonds:

Par Value: Par value is also known as the Face value or Principal amount return to the Bondholder on the maturity date.

Rate of Interest: It is known as a Coupon Rate of the bond.

Date of Redemption: The date at which the face value of the bond should be paid on maturity of the bond.

Callable feature: Allow a CALL of the bond issuer at a specific price before their scheduled maturity.    

What are Zero-coupon Bonds?

 Zero-coupon Bond issuer only pays the face value of the bond at a discount price on maturity price. The issuer does not pay any coupon rate to the zero-coupon bondholder, throughout the maturity. It is only at a discounted price. It is purchased at a lower price is known as a Deep Discount Bond. The difference between the bond issue price and the face value of the bond is the profit of the bondholder. Another significant aspect is that investors do not have to pay any interest tax because the bonds are sold at a discounted price and are redeemed at a face value. It has zero reinvestment risk. It is useful for a long-term investor with minimum risk-takers.

Example:

For Example, XYZ company issue a zero-coupon bond to Mr. ABC at a price of 800rs for a face value of 1000rs bond for the term of 5years. Here in the zero-coupon bond, XYZ company did not pay any coupon rate to Mr. ABC, but Mr. ABC has received 200rs profit when receives 1000rs on the maturity date. During 5 years of the bond duration, the bondholder didn’t receive any interest.

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What are Regular Coupon Bonds?

Regular coupon bonds issuer (holder) pays (receives) coupon rate on regular intervals throughout the maturity date.  He receives the coupon rate on a quarterly or half-yearly or yearly basis. Coupon bonds trade near to the price of the bond. Coupon bonds have regular cash flows. Coupon bonds have profits on coupons or interest rate bonds.

Example:

For Example, XYZ company issue a coupon bond to Mr. ABC for a face value of a 1000rs bond for the term of 5 years at a coupon rate of 10% per year on maturity. Here in coupon bond, XYZ company pays coupon rate to Mr. ABC on the maturity date. During 5 years of the bond duration, every year the bondholder has received interest at 5% on face value and after the maturity, the bondholder also receives the face value of 1000rs.

Conclusion: Regular coupon bonds have the receives periodical interest rate but the zero-coupon bond didn’t any interest.

 

Author: John Earla

About Author: Currently pursuing Financial Risk Management from GARP(US) and completed Graduation in Bcom computers. John is interested in finance and also Risk Analysis.

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