A Zero-Coupon Bond, also known as a discount bond or zeroes, is a financial instrument that does not pay interest during its lifetime. Instead of periodic interest payments, a Zero-Coupon Bond is sold at a steep discount to its nominal or face value, and the bondholder receives the face value amount upon maturity.
For example, imagine a Zero-Coupon Bond with a face value of $1,000 that matures in 10 years. This bond might be sold today for $500, and upon maturity, the holder of the bond would receive $1,000. The difference, $500, represents the interest that accrues over this period. The longer the maturity, the steeper the discount at which the bond is sold from its face value.
Corporations, municipalities, and governments commonly issue Zero-Coupon Bonds as a way to raise capital. These bonds can be useful for long-term savings objectives since their returns are predictable and they provide a lump sum payment at the end of the term. However, it's worth noting that tax rules in certain jurisdictions may require bondholders to report annual accrued interest income even though they do not receive periodic interest payments.