When I explain fixed income instruments to investors, I start with a simple truth: every bond is a promise of cash flows. A regular coupon bond pays periodic interest and then returns principal at maturity. A zero coupon bond is different—it pays no periodic interest at all. Instead, it is issued at a discount to its face value (also called par value) and redeemed at face value on maturity. The investor’s return is the difference between what they paid today and what they receive at the end.

If you’ve ever wondered what is zero coupon bonds in practical terms, I describe them as “single-pay bonds”: one payment in the future, one price today.

Why do issuers offer zero coupon bonds?

Issuers may prefer zero coupons because they don’t have to service periodic interest outflows. This can suit long-term projects or funding plans where cash flows are expected later. Investors may like them because the return profile is predictable if held to maturity—assuming the issuer repays in full.

The core idea behind valuation: present value

Valuing a zero coupon bond is conceptually clean because there is only one future cash flow: the maturity value. The price is simply the present value of that future amount, discounted at an appropriate rate (the yield).

A simplified valuation formula is:

Price = Face Value ÷ (1 + Yield)ⁿ

Where:

• Face Value is what you receive at maturity
  
  
• Yield is the required annual return (YTM for a zero coupon)
  
  
• n is the number of years to maturity
  
  

In real markets, compounding conventions (annual vs semi-annual), day count, and settlement dates can slightly refine the calculation—but the intuition stays the same.

A quick example (to make it tangible)

Suppose a zero coupon bond will pay ₹1,00,000 after 5 years. If investors demand a yield of 7%, its value today would be approximately:

₹1,00,000 ÷ (1.07)⁵ ≈ ₹71,299

Now, watch what happens when yields move—this is the most important “valuation lesson” in bonds:

• If the required yield rises to 8%, the price falls to about ₹68,058
  
  
• If the required yield drops to 6%, the price rises to about ₹74,726
  
  

This sensitivity to interest rates is why zero coupon bonds can be more volatile than similar-maturity coupon bonds: there are no interim cash flows to “pull” the price back through reinvested coupons.

What should I look at before investing?

When I evaluate a zero coupon bond, I focus on four practical factors:

1. Credit risk: The maturity payment is everything. I look at issuer quality, structure, and documentation.
   
   
2. Interest-rate risk: Longer maturities typically mean larger price swings when yields change.
   
   
3. Liquidity: If I may need to exit early, I check how actively it trades and what bid–ask spreads look like.
   
   
4. Tax treatment: Returns may be treated differently across jurisdictions and instruments (sometimes accrual-based). I always recommend confirming with a tax professional.
   
   

Final thought

Zero coupon bonds are elegant instruments: one future payment, priced by discounting. Once you understand the present value logic, you can interpret market prices with much more confidence—whether you invest through a broker, a platform, or choose to invest in bonds online after doing your due diligence.