Traditionally bonds pay interest semi-annually, however, a Zero Coupon Bond is a fixed income security that makes no interest payments. Instead, all interest accrues and is paid only at maturity
Zero Coupon Bonds are offered at a substantial discount from par so the original investment can be as little as $250 versus the $5,000 required for traditional bonds. And because the Zero Coupon Bond automatically produces a compounded return, you never have to worry about reinvesting interest payments received during the life of the bond. All interest that the bond earns compounds in growth from the original purchase rate to the par value at maturity.
Not only is the need and risk of reinvesting interest eliminated, but the investor knows exactly how much growth the capital of the Zero Coupon Bond will attain by maturity.
Zero Coupon Bonds enjoy the same quality standards as those of traditional bond investments. The majority of Zero Coupon Bond issues are rated "A" or better by the two leading investment services, Moody's and Standard & Poor's.
Zero Coupon Bonds, like all other fixed income instruments, are subject to inflationary risk. If interest rates rise, the price of these bonds will fall. Due to the compounding nature of Zero Coupon Bonds, the fall in prices due to higher interest rates may be disproportionately higher than with other non-compounding fixed income instruments.
Zero Coupon Bonds are available in a wide range of maturities and can be purchased in both primary (new issues) and secondary markets.