Why do zero-coupon bonds always trade at a discount? (2024)

Why do zero-coupon bonds always trade at a discount?

Answer and Explanation:

Why zero-coupon bond issued on discount?

These bonds are issued at a deep discount and repay the par value, at maturity. The difference between the purchase price and the par value represents the investor's return. The payment received by the investor is equal to the principal invested plus the interest earned, compounded semiannually, at a stated yield.

Why do bonds trade at a discount?

Bonds are sold at a discount when the market interest rate exceeds the coupon rate of the bond. To understand this concept, remember that a bond sold at par has a coupon rate equal to the market interest rate.

Why are zero-coupon bonds so volatile?

It can be a wild ride. Because they do not pay any periodic interest, zero-coupon bonds tend to be more volatile than their conventional counterparts. Of course, if held until maturity, the payout will be predetermined and does not change.

Which bond always trades at a discount?

Zero coupon always trade at discount. Zero coupons bonds does not pay any coupon, investor get p[aid th…

Are zero-coupon bonds tradable?

Instead, the zero-coupon bonds are traded with huge discounts yet return good profits on getting mature on their face value. Their purchasing price and par value determine the return of these coupons. Zero Coupon Bonds do not pay any interest during the life of the bonds.

Are zero-coupon bonds sold at a discount?

Zeros, as they are sometimes called, are bonds that pay no coupon or interest payment. With a zero, instead of getting interest payments, you buy the bond at a discount from the face value of the bond and are paid the face amount when the bond matures.

Why are bonds sometimes issued at a discount?

The amount a bond sells for below face value is a discount. A difference between face value and issue price exists whenever the market rate of interest for similar bonds differs from the contract rate of interest on the bonds.

Why are bonds sometimes issued at a discount quizlet?

When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate.

What is the difference between a discount bond and a zero coupon bond?

Since zero coupon bonds do not pay any periodic interest payments, investors are not required to pay any taxes on the interest income. However, deep discount bonds may have a coupon rate and investors are required to pay taxes on the interest income.

Why do traders love zero-coupon bonds compared to coupon bonds?

The Difference for Investors

Interest payments cut down the wait time and the risk, so they also reduce expected returns. The absence of coupons does not make zero-coupon bonds bad investments, and they usually offer better returns than coupon bonds.

Why do bonds sell at a discount or premium?

The market value of a bond can vary from its face value. When a bond's value exceeds its face value, it sells at a premium. Conversely, the bond sells at a discount when the market value is less than the par value.

How do zero-coupon bonds trade?

Zero-coupon bonds trade at a discount and don't pay interest during the term of the bond. The interest isn't invisible to the IRS and must be reported and taxes owed must be paid as if the interest had been received.

Why are discount bonds more volatile?

Generally, bonds with long maturities and low coupons have the longest durations. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing rate environment.

Why are low coupon bonds more volatile than high coupon bonds?

Bonds with lower coupons are generally more sensitive to interest rates than their higher-yielding counterparts. Because they receive a smaller share of payments early on in their payment schedules, their present values depend more on their larger payments at maturity.

Why do bonds trade at different prices?

Most bonds are issued slightly below par and can then trade in the secondary market above or below par, depending on interest rate, credit or other factors. Put simply, when interest rates are rising, new bonds will pay investors higher interest rates than old ones, so old bonds tend to drop in price.

When bonds are trading at a discount which statement is true?

Answer and Explanation: The correct option is d. It will be sold for less than the face value. A bond that sells at discount usually has a higher par value than its price.It is also declared at a price lower than the par value.

What is a zero-coupon trade?

A zero-coupon swap is an exchange of cash flows in which the stream of floating interest-rate payments is made periodically, as it would be in a plain vanilla swap, but where the stream of fixed-rate payments is made as one lump-sum payment at the time when the swap reaches maturity, instead of periodically over the ...

How are zero-coupon bonds priced?

The target purchase price of a zero coupon bond, assuming a desired yield, can be calculated using the present value (PV) formula: price = M / (1 + i)^n. M is the face value at maturity, i is the desired yield divided by 2, and n is the number of years remaining until maturity times 2.

What is a big disadvantage of zero-coupon bonds?

While you'll be able to buy zeros at deep discounts to face value, you won't receive anything in return for your investment until the term of the bond ends. Along the way, you'll be subject to higher levels of interest rate risk (if interest rates rise) and inflation risk (if prices rise generally in the economy).

Is a discount bond good or bad?

Premium bonds trade above par value while discount bonds trade below it. Discount bonds can be riskier but the lower the price, the higher the potential for gains. Premium bonds can deliver higher returns with less risk, but they can be problematic if they become callable.

How do you know if a bond will be issued at a discount?

Answer and Explanation: The difference between a bond's stated interest rate and the current market interest rate determines whether or not it is issued at a discount or a premium. A bond will be issued at a discount if its coupon rate is below the going interest rate.

Why does a bond sell at a discount when the coupon rate is lower than the required rate of return and vice versa?

A bond that offers bondholders a lower interest or coupon rate than the current market interest rate would likely be sold at a lower price than its face value. This lower price is due to the opportunity investors have to buy a similar bond or other securities that give a better return.

Why does a bond sell at a discount when the coupon rate is lower than the required rate of return?

Bond Coupon Rate

If a bond's coupon rate is below the market yield, the bond will trade below its par value i.e. at a discount. This happens because investors will require the yield of the bond to be in line with existing market yields.

Do bonds with high coupon tend to sell at higher or lower prices Why?

The Bottom Line

The prevailing market interest rates affect the coupon rate of a bond, and this, ultimately, affects the price of the bond. As a rule of thumb, if a coupon rate is higher than the prevailing market interest rate, the bond's price rises; if the coupon is lower, the bond's price falls.