Zero Coupon Bonds: Meaning, Example, and How They Work

What Are Zero Coupon Bonds?

Zero coupon bonds are fixed-income securities that do not pay regular interest or coupon payments during their tenure. Instead, they are issued at a deep discount to their face value and redeemed at full face value upon maturity.

For example, an investor may buy a zero coupon bond with a face value of ₹10,000 at ₹7,000. At maturity, they will receive the full ₹10,000, earning ₹3,000 as the return.

The key feature is that all the interest (or yield) is realized at the end of the tenure, making them suitable for investors who can hold till maturity and prefer long-term compounding.

How Zero Coupon Bonds Work

Unlike regular bonds that pay periodic interest, zero coupon bonds are structured so that investors receive a lump-sum payment at maturity. Here’s how the process typically works:

1. Issued at a Discount:

The bond is sold below its face value (e.g., ₹6,500 for a ₹10,000 bond).

2. No Periodic Coupons:

The issuer doesn’t pay annual or semi-annual interest.

03. Maturity Payment:

At the end of the term, the investor receives the full face value.

04. Earnings:

The difference between the purchase price and redemption value is treated as interest income or capital gain (depending on the tenure and tax treatment).

This makes zero coupon bonds particularly appealing to investors who want a predictable, lump-sum payout at a specific future date, such as for education or retirement planning.

Zero Coupon Bonds Example

To understand better, consider this illustrative example:

• Issuer: Government or corporate entity

• Face Value: ₹10,000

• Issue Price: ₹7,000

• Tenure: 10 years

• Maturity Amount: ₹10,000

• Implied Yield: Approximately 3.9% per annum

In this case, the investor earns ₹3,000 over 10 years, representing the cumulative interest accrued through compounding.

Types of Zero Coupon Bonds

Zero coupon bonds can be broadly classified based on the issuer:

• Government Zero Coupon Bonds

These are issued by government bodies and considered low-risk. For example, some long-term government securities are structured as zero coupon instruments.

• Corporate Zero Coupon Bonds

Companies issue these to raise funds without paying regular interest. They usually carry higher risk than government bonds but can offer better yields.

• Municipal or Institutional Bonds

Certain public sector or institutional projects may issue zero coupon instruments for long-term financing needs.

Zero Coupon Bonds in India

In India, zero coupon bonds have been issued by both government entities and corporations. While they are less common than coupon-paying bonds, they serve specific investor needs.

• Issued by: Financial institutions, government bodies, and select corporates.

• Listed on: Recognized stock exchanges or traded via Online Bond Platform Providers (OBPPs) like BondScanner.

• Regulated by: The Securities and Exchange Board of India (SEBI) and settled through clearing corporations for transparency and safety.

These bonds are often used for long-term wealth accumulation, especially for investors looking for certainty of returns at a fixed future date.

Benefits of Zero Coupon Bonds

Predictable Returns:

The return is known upfront since it’s the difference between purchase and redemption value.

No Reinvestment Risk:

As there are no periodic coupons, there’s no concern about reinvesting interest payments at fluctuating rates.

Long-Term Planning:

Ideal for meeting future financial goals like education, marriage, or retirement.

Diversification:

Zero coupon bonds can complement traditional interest-bearing securities, adding a stable long-term component to a portfolio.

Risks of Zero Coupon Bonds

Despite their benefits, investors should be aware of certain risks:

• Interest Rate Risk:

Bond prices fall when interest rates rise. Since zero coupon bonds have no interim payouts, their prices are more sensitive to rate changes.

• Credit Risk:

Corporate-issued zero coupon bonds may carry default risk. Always check the issuer’s credit rating before investing.

• Liquidity Risk:

These bonds are not as actively traded, meaning selling before maturity may be difficult.

• Tax Implications:

The accrued interest may be taxable even though the investor hasn’t received cash flows until maturity.

How to Buy Zero Coupon Bonds in India

Zero coupon bonds can be purchased through several channels:

• Online Bond Platforms:

SEBI-registered OBPPs like provide access to listed and unlisted bonds, including zero coupon options.

• Stock Exchanges:

Investors can buy these bonds in the secondary market via demat accounts.

• Banks and Financial Institutions:

Some issuers make them available directly through authorized dealers or distribution partners.

Before investing, always review the bond’s face value, tenure, credit rating, and yield-to-maturity (YTM) to make an informed decision.

Who Should Consider Investing in Zero Coupon Bonds?

Zero coupon bonds are suitable for investors who:

• Prefer long-term, predictable returns.

• Can hold till maturity without needing liquidity.

• Seek diversified exposure in fixed-income instruments.

• Want to plan for future expenses with a clear maturity value.

They may not be ideal for investors needing regular income, as there are no periodic interest payouts.

Tax Treatment of Zero Coupon Bonds in India

The tax treatment depends on how long the bond is held:

• Short-Term (less than 12 months):

Gains are taxed as per the investor’s income slab.

• Long-Term (more than 12 months):

Gains are taxed at 10% without indexation or 20% with indexation, depending on the nature of the instrument.

Investors should consult a tax advisor to understand the applicable rules before investing.

FAQs

1. What are zero coupon bonds used for?

They are primarily used for long-term savings goals, offering a lump-sum return at maturity without periodic payouts.

2. Are zero coupon bonds available in India?

Yes, both government and corporate entities issue zero coupon bonds in India, which can be purchased via online bond platforms or exchanges.

3. How are zero coupon bonds different from regular bonds?

Regular bonds pay periodic interest (coupons), while zero coupon bonds provide a single payout at maturity.

4. Are zero coupon bonds risk-free?

Government-issued ones are relatively safe, but corporate zero coupon bonds carry credit and interest rate risks.

5. Can I sell a zero coupon bond before maturity?

Yes, but it depends on market liquidity. Prices may vary based on prevailing interest rates and demand.