Zero Interest Bonds
Zero-interest Bonds/Debenture is the bond which issues without interest payment, they are sold at discounted, so investors can get some profit on the maturity date. They are usually trading at a huge discount on the issued date while offering a full par value on the maturity date. The difference between the par value and the selling price is the investors’ profit.
Bond is the financial instrument which the issuer sells in the capital market and promise to pay annual interest and face value on the maturity date. For the zero-interest bonds, the investors will not receive annual interest income. They purchase bonds at discount and receive the full amount on the maturity date.
This kind of bond will help the issuers to save some cash flow as they do not worry about annual interest payment. However, they need to provide a huge discount to compensate for this. It is the concept of the time value of money where $1 today is more valuable than $ 1 in one year’s time.
Zero Interest Bonds Price
Price = Face Value / (1+r)n
- Face Value: is the future value that will receive on the maturity date.
- r: is the required rate of return
- n: is the number of the year till the maturity date
Zero Interest Bonds Example
For example, Mr. A purchased zero-interest bonds that have a face value of 10,000 and will be matured in 6 years. The market interest rate is 8% per year.
Price = 10,000 / (1+8%)6 = $ 6,301
It means that Mr. A needs to pay $ 6,301 to purchase the bond which will expect to receive $ 10,000 on the maturity date in the next 6 years. He will not receive any interest payments during the time of holding bonds.