6 month zero coupon bond
Generally, bonds that are riskier will require a higher rate of return in order to attract buyers.
Risks can include the potential for default the bond issuer being unable to pay back the bond holder or the risk of a future increase in the interest rate of new bonds, which will decrease the attractiveness relative value of the present bond. Also the longer the remaining time until the bond matures and pays out its final value, the riskier the bond is simply because of the increased potential for payout problems inherent in longer periods of time.
Thus, for purposes of this formula, you would add 1 to 0. Determine the number of time periods years in this case remaining until the bond matures. For example, if the bond issuer will pay the bond holder the face value of the bond in five years, then the time-to-maturity is five. Take the sum calculated in Step 1 above and raise it to the power of the remaining time period. Thus, 1.
On a calculator, you would multiply 1. Divide the par face value of the bond by the result of the previous step. The par value of the bond is the amount that the bond issuer will pay to the bond holder when the bond matures.
Unanswered Questions. Does a zero-coupon bond have compounding frequencies such as quarterly or monthly; if there is a specific compounding frequency, how is the YTM computed?
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Warnings Make sure that the required rate of return and the number of time periods remaining until maturity are measured in the same units of time. In the above example, the stated interest rate was an annual one, and the number of time periods until maturity was measured in years.
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References Investopedia: For tax purposes, the IRS maintains that the holder of a zero-coupon bond owes income tax on the ir that has accrued each year, even though the bondholder does not actually receive the cash until maturity. The IRS calls this imputed interest. Zero-coupon bonds are usually long-term investments ; they often mature in ten or more years.
Although the lack of current income provided by zero-coupons bond discourages some investors, others find the securities ideal for meeting long-range financial goals like college tuition. The deep discount helps the investor grow a small amount of money into a sizeable sum over several years.
Zero Coupon Bond Value
Because zero-coupon bonds essentially lock the investor into a guaranteed reinvestment rate , purchasing zero-coupon bonds can be most advantageous when interest rates are high. 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.
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