What are ‘Zero Coupon Bonds’

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Definition :

Zero Coupon Bonds or ZCBs have no “coupon” or interest rate/ payments attached during the tenure of the bond. To compensate this, ZCB is issued at a discounted price, which is less than its face value. At the time of maturity, investors receive the payment at face value. The positive difference between the face value and the discounted price is the profit. These bonds have duration equal to the maturity, which makes them sensitive to any change in the interest rates. ZCBs are listed on stock exchanges.

Implications :

Technically ZCBs can be for short or long term. But mainly they are for long term and hence are suitable for investors with long-term horizon. For other investors, the benefits of ZCBs are available through mutual fund debt schemes as it can be a part of their debt portfolio. There are no coupon payments in zero coupon bonds. So these bonds are taxed under the head ‘income’ from capital gains. Long term capital gains attract indexation benefits. In case of short-term capital gains, it will be included in the investor’s total income and tax rate will be as per the tax slab in which the investor belongs.

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