Bonds that pay no coupons and are sold at a discount to face value are called what?

• A. Zero Coupon Bonds
• B. Coupon Bonds
• C. Investment Bonds
• D. Junk Bonds

Answer: (A)

Zero coupon bonds pay no periodic interest. They are issued at a discount to their face value and repay the full face value at maturity. The return comes from the difference between the purchase price and the amount received at maturity, so the price today reflects the present value of receiving the face value later. As time passes, the price rises toward the face value even though no cash is paid until maturity, and the yield to the investor is the rate that equates the discounted purchase price to the eventual payment at maturity. For example, a bond with a 100 face value and a 5-year maturity might trade for less than 100 today and then pay 100 at maturity, delivering the investor’s return entirely through price appreciation.