What are zero coupon bonds, and why should your company consider them?

When you look into investing, you are inundated with choices. You can choose from stocks or bonds, and then within those two groups you have another million choices, or so it seems. So, let's take a look at one type of bond, and what it means to your company and investing-zero coupon bonds!

What are zero coupon bonds?
Zero coupon bonds are corporate, municipal, or treasury bonds that pay no annual interest. You can deduct this by the fact that coupon rate is simply another term for interest rate, so a zero coupon bond is a bond that pays zero interest.

So, how does an investor make money on a zero coupon bond if it does not pay interest?
When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus interest that has accrued.

Why should your company consider them?
You can buy zero coupon bonds at deep discounts and then redeem them for full value at maturity. So, in other words, you get them at a discount, so while you earn nothing while you hold them, you get more from them at maturity. So, the profit on that difference in value replaces the annual interest.

The maturity dates on zero coupon bonds are usually long-term-many don't mature for ten, fifteen, or more years. So, your company needs to take these long-term maturity dates into account before investing. However, they are a benefit because they allow an investor to plan for a long-range goal, such as building a new office, or going global, etc. With the deep discount, an investor can put up a small amount of money that can grow over many years.

So what makes zero coupon bonds worth buying?
Well, zeros allow you to buy more bonds for your money. It is great for those who have plenty of money to invest, and are not looking for a quick return. Your return is higher, but it is a long-term investment. It will likely be several years before you get any money out of them.

So, are there and drawbacks to zero coupon bonds?
Well, while you can buy more for less, you need to be careful because you might be taxed annually as if you earned interest even if you don't actually receive the interest. So, you will want to be careful to talk to your tax advisor or financial advisor about avoiding this, or at least preparing for it. Otherwise you will be in trouble financially, and not be able to pay your taxes on the bonds.

Some investors avoid paying the imputed tax by buying municipal zero coupon bonds (if they live in the state where the bond was issued) or purchasing the few corporate zero coupon bonds that have tax-exempt status. You will want to make sure that you check the tax status of any of the bonds you buy, municipal, treasury, etc.

So, how do you, as an investor purchase zero coupon bonds?
As an investor you can purchase different kinds of zero coupon bonds in the secondary markets that have been issued from a variety of sources, including the U.S. Treasury, corporations, and state and local government entities. So, what you need to do is determine what type of bonds you want, and what the ramifications of purchase are.so determine if you want to pay taxes along the way, or add maturity.

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