The expression zero coupon indicates a financial security that does not pay periodic interest. Those who invest therefore do not receive coupons during the life of the security but obtain the entire profit together with the maturity.
This is a term that often appears when talking about bonds, government bonds and safe investments but it is not always clear what it really means and how it works in practice.
So what are the most popular financial products of this type and what is the difference between a security with a coupon and one without?
How zero coupons work
The term zero coupon indicates a financial security whose yield is given by the difference between the purchase price and the value reimbursed at maturity.
This means that the profit does not arrive every 6 months as happens with traditional bonds but is obtained in full at the end.
A zero coupon bond is in fact issued at a lower price than the final value and the investor earns precisely on that difference.
To better understand how it works, here is a simple example:
if a security is worth 1,000 euros at maturity it can be purchased earlier for 950 euros. At maturity, then, the State returns 1,000 euros so the profit of those who invested is 50 euros and derives precisely from the difference between the price paid at the beginning and the value reimbursed at the end.
They therefore do not have coupons. which are paid during the life of the security.
What are the most popular zero coupon products
In Italy there are two large categories of bonds. There are those with coupons, which pay periodic interest, and those with zero coupons which return the entire yield at maturity.
Those with zero coupons are the following:
- Bots or ordinary Treasury bills
- the Ctz which are zero coupon Treasury certificates;
- CCTEUs or zero coupon Treasury credit certificates in euros;
- zero-coupon corporate bonds or zero-coupon hedge bonds;
- structured bonds without coupon.
The securities with coupons are instead:
- BTPs or multi-year Treasury bonds;
- traditional bank bonds;
- corporate bonds with fixed or variable coupons.
Which are the Bots, Ctz and Ccteu zero coupons
Bots are short-term government bonds, usually lasting 3, 6 or 12 months. They do not pay coupons as the profit comes from the difference between the purchase price and the final value at maturity.
Ctz are also short-term government bonds that work like Bots but have a slightly longer duration, up to two years. They have no coupon and the yield is given by the difference between the initial price and the value at maturity.
CCTEUs, on the other hand, are certificates linked to government bonds that do not pay periodic interest. The yield, in fact, is obtained all together with the maturity and their duration is usually between 2 and 10 years depending on the issue.
What are zero coupon corporate bonds
Zero coupon corporate bonds are bonds issued by private companies such as companies, credit institutions or industrial groups that do not pay periodicals. The yield, therefore, is not paid at regular intervals but all together at the maturity date.
They work like this:
the company issues the bond at a price lower than the nominal value, precisely because it will not pay intermediate interest. Whoever buys the security then keeps it until maturity and receives the full amount at the end.
The main advantage for the issuer is that it does not have to manage periodic payments while for the investor it can be interesting to accumulate capital in view of a future objective. However, it should be considered that the risk is higher than that of government bonds, because it depends on the financial solidity of the issuing company and there is no state guarantee.
Which are structured securities without coupons
Structured securities are more complex financial instruments than traditional bonds. These are not just securities with or without coupons but products that combine a bond component with derivative instruments, such as options or other financial assets.
This type of securities can include:
- a portion of debt;
- one or more derivative components that link the return to interest rates, stock indices or other assets.
Some of these securities do not pay periodic coupons because the return depends on the behavior of an index or specific market events.
Instead of traditional coupons, therefore, investors can obtain:
- a return linked to the performance of an index or basket of assets,
- no return if the conditions do not occur;
- partial capital protection if the index does not perform.
Typically, these tools are used to customize the risk profile and return of an investment to an investor’s needs. They are also issued by financial institutions or banks for customers who have some experience. They can be complex and less liquid so it is essential to read the prospectus carefully to understand how they work and what risks they involve.
When it is best to choose zero coupon securities
There is no one-size-fits-all rule when it comes to choosing zero coupon stocks. However, they can be useful if you want to obtain a precise sum on a specific date, such as for a future expense.
They could also be suitable for those who do not need to obtain interest every six months but prefer to grow the capital and receive everything at maturity.
