What characterizes zero coupon bonds?

Zero coupon bonds are characterized by their unique structure, where they do not pay periodic interest, known as coupons. Instead, these bonds are issued at a discount to their face value and the investor receives the face value at maturity. This means that the difference between the purchase price of the bond and its maturity value represents the return for the investor.

For example, if a zero coupon bond is issued with a face value of $1,000 and sold for $700, the investor essentially earns a return of $300 when the bond matures. This return is realized all at once at maturity rather than through periodic interest payments over the life of the bond. This structure makes zero coupon bonds appealing to certain investors who might prefer to have a lump sum at the end of the investment period rather than regular interest payments.

Understanding this characteristic helps investors recognize that zero coupon bonds can be a suitable investment for those with specific cash flow needs or goals, such as saving for a future financial obligation, since they provide a predictable return without interim cash flow.