Coupon Bond Definition & Example | InvestingAnswers
For this reason, zero-coupon bonds are often purchased to meet a future expense such as college costs or an anticipated expenditure in retirement. Federal agencies, municipalities, financial institutions and corporations issue zero-coupon bonds. A financial institution, government securities broker or government securities dealer can convert an eligible Treasury security into a STRIP bond.
As the name implies, the interest is stripped from the bond. A nice feature of STRIPS is that they are non-callable, meaning they can't be called to be redeemed should interest rates fall.
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This feature offers protection from the risk that you will have to settle for a lower rate of return if your bond is called, you receive cash, and you need to reinvest it this is known as reinvestment risk. That said, zero-coupon bonds carry various types of risk. Instead, bonds are formed electronically, though some holders still prefer to own paper certificates.
For this reason, the coupon bond simply refers to the rate it projects rather than its physical nature in the form of certificates or coupons. For the investor to claim his interest on the bond, he simply takes the corresponding coupon from the provided bond certificate and gives it to an agent of the issuing institution. Coupon bonds are usually bearer bonds. Anyone who provides the necessary coupons to the issuer can receive the interest payment regardless of whether that person is the actual owner of the bond.
What Is a Zero-Coupon Bond?
For this reason, coupon bonds present a lot of opportunities for tax evasion and other fraudulent acts. Modern bonds are typically registered bonds with physical certificates that provide the terms of the debt and the name of the registered holder who receives interest payments automatically from the issuing institution.
Some bonds are in the form of book entry bonds, which are electronically registered and linked to the issuer and its investors. In book entry bonds , the investor gets receipts instead of certificates. Investors also get accounts handled by financial institutions.
They are able to receive their interest payments through these accounts. Your Money. They are also more advantageous when placed in retirement accounts where they remain tax-sheltered. Some investors also avoid paying taxes on imputed interest by buying municipal zero-coupon bonds, which are usually tax-exempt if the investor lives in the state where the bond was issued. The lack of coupon payments on zero-coupon bonds means their worth is based solely on their current price compared to their face value.
Thus, prices tend to rise faster than the prices of traditional bonds when interest rates are falling, and vice versa. The locked-in reinvestment rate also makes them more attractive when interest rates fall. Show 5 More. Our in-depth tools give millions of people across the globe highly detailed and thoroughly explained answers to their most important financial questions.
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