Zero Coupon Bonds in India | Advantages & How to Invest - BondsIndia (2024)

FAQs

Zero Coupon Bonds in India | Advantages & How to Invest - BondsIndia? ›

More About Zero Coupon Securities in India

Zero-coupon government bonds can be purchased directly from the Treasury at the time they are issued. After the initial offering, they can be purchased on the open market through a brokerage account. Other types of zero-coupon bonds can also be purchased using a brokerage account.

As mentioned above, investors of notified zero coupon bonds issued by NABARD and REC are liable to pay only capital gains tax on maturity. Capital appreciation, in such cases, is the difference between the maturity price and the purchase price of the bond.

Zero-coupon bonds are issued at a deep discount and repay the par value at maturity. The difference between the purchase price and the par value represents the investor's return. The payment received by the investor is equal to the principal invested plus the interest earned, compounded semiannually, at a stated yield.

Zero coupon bonds are issued by the Reserve Bank of India (RBI) on behalf of the Central Government. Only a few government organisations issue zero coupon bonds with approval from the Ministry of Finance.

Disadvantages include the lack of periodic income, interest rate risk, credit risk, and unfavorable tax implications for certain investors in corporate and treasury zero-coupon bonds.

In the U.S., zero-coupon bonds create a tax liability for interest payments, even though they don't actually pay periodic interest. That creates a phantom income problem for the bondholders. 1 It can be challenging to come up with the money to pay taxes on income that was not received.

Zeros, as they are sometimes called, are bonds that pay no coupon or interest payment. With a zero, instead of getting interest payments, you buy the bond at a discount from the face value of the bond and are paid the face amount when the bond matures.

Zero coupon bond rates

Zero coupon bonds are issued at various rates ranging from 3% (short term government zero coupon bonds) up to 10% (long term corporate zero coupon bonds).

Taxation of Zero Coupon Bonds

No TDS Deduction: The accrued interest on these bonds does not attract TDS (Tax Deducted at Source), requiring investors to account for this tax liability in their annual income tax returns.

Why would anyone buy a zero-coupon bond? ›

While these bonds don't offer the steady stream of income that conventional bonds do, zero-coupon bonds are often purchased to meet a future expense such as college costs or an anticipated expenditure in retirement.

A zero-coupon bond is a bond that pays no interest and trades at a discount to its face value. It is also called a pure discount bond or deep discount bond. U.S. Treasury bills are an example of a zero-coupon bond.

The return to the investor of a zero-coupon bond is equal to the difference between the face value of the bond and its purchase price. In exchange for providing the capital in the first place and agreeing not to be paid interest, the purchase price for a zero-coupon is less than its face value.

Gains from zero coupon bonds are subject to capital gains tax on maturity. The capital appreciation for zero coupon bonds is the difference between the maturity price and purchase price of the bond.

The basic method for calculating a zero coupon bond's price is a simplification of the present value (PV) formula. The formula is price = M / (1 + i)^n where: M = maturity value or face value. i = required interest yield divided by 2.

Yield to maturity (YTM) tells bonds investors what their total return would be if they held the bond until maturity. YTM takes into account the regular coupon payments made plus the return of principal. Zero-coupon bonds do not pay interest at regular intervals.

While you'll be able to buy zeros at deep discounts to face value, you won't receive anything in return for your investment until the term of the bond ends. Along the way, you'll be subject to higher levels of interest rate risk (if interest rates rise) and inflation risk (if prices rise generally in the economy).

Investors can purchase different kinds of zero coupon bonds in the secondary markets that have been issued from a variety of sources, including the U.S. Treasury, corporations, and state and local government entities.

The target purchase price of a zero coupon bond, assuming a desired yield, can be calculated using the present value (PV) formula: price = M / (1 + i)^n. M is the face value at maturity, i is the desired yield divided by 2, and n is the number of years remaining until maturity times 2.

Yield to Maturity of Zero Coupon Bond Formula (YTM)

To calculate the yield-to-maturity (YTM) on a zero-coupon bond, first divide the face value (FV) of the bond by the present value (PV). The result is then raised to the power of one divided by the number of compounding periods.