Zero-Coupon Bond
Also known as: Zero, Strip, Discount bond
No coupons, one payment: buy at a discount, collect face value at maturity. The purest interest-rate instrument.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A zero-coupon bond skips the periodic interest payments entirely. You buy it below face value — say 70 for a bond that pays 100 in ten years — and your whole return is that built-in climb from 70 to 100.
Nothing to reinvest, nothing to track: one payment, one date. That makes zeros perfect for funding a known future expense — a tuition bill in 2035, a pension payment in 2040 — with no uncertainty about reinvesting coupons along the way.
The flip side: with all the money arriving at the very end, zeros are the most rate-sensitive bonds of their maturity. Long zeros can swing like stocks when yields move.
Point at a line to read what it is doing.
How do I read this chart?
Yield runs across, price up. The line falls, which is the whole of the relationship between the two — and it is curved rather than straight, which is convexity and the reason a bond gains more when yields fall than it loses when they rise by the same amount.
Where this is explained properly:
The axes carry no scale on purpose. Every line here is a stylised shape drawn to show a mechanism, so there is no number to read off one — and any figure taken from it would be invented.
- Asset class
- Fixed income
- Instrument type
- Discount bond
- Traded
- OTC (incl. stripped Treasuries)
- Typical users
- Liability matchers, rate traders, quants
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditmatters
- Liquiditymatters
- Fundingbarely applies
- Operationalbarely applies
What decides it here. One payment at the end and nothing in between, so the price moves further for a given change in rates than any coupon bond of the same maturity.
3 · IntermediateHow it works in practice
Where zeros come from
- Issued directly: T-bills are natural short-term zeros; some governments and corporates issue longer ones.
- Stripping: dealers separate a coupon bond into individually tradable pieces — each coupon and the principal become standalone zeros (US "STRIPS").
Yield and price
The relationship is a single compound-interest equation. At an annually compounded yield \(y\) and maturity \(T\): price = 100/(1+y)^T. A 10-year zero at 4% costs 67.56; the same bond at 5% costs 61.39 — a 9% price drop for one point of yield.
Duration = maturity
Because there is only one cash flow, a zero's (Macaulay) duration equals its maturity exactly — the cleanest possible rate exposure. Pension funds discharging a 2045 liability buy 2045 zeros and simply stop worrying about rates ("immunisation" in its purest form).
Tax wrinkle
Many jurisdictions tax the accrued discount annually ("phantom income") even though no cash arrives — one reason zeros often live in tax-sheltered accounts.
4 · AdvancedPricing & valuation
The discount function
Zero prices are the discount factors of the curve: \(P(0,T) = e^{-z(T)\,T}\) in continuous compounding. Every fixed-income valuation reduces to a weighted sum of these:
What the symbols mean
- Va value
- Cthe price of a call option
- Fthe forward or futures price
- Pa price, or a present value
- ta point in time
Bootstrapping the discount function from coupon-bond or swap quotes is the first step of every pricing library.
Forward rates from zeros
What the symbols mean
- ta point in time
- Pa price, or a present value
The instantaneous forward curve \(f(t) = -\partial_T \ln P(0,T)\) is the input to HJM-class term-structure models, where the entire no-arbitrage drift is determined by volatility structure alone.
Convexity of zeros
Modified duration \(T/(1+y)\) and convexity ≈ \(T(T+1)/(1+y)^2\): convexity grows with maturity squared. Long zeros are therefore the cheapest convexity in bond markets — barbelling zeros against selling coupon bonds is a classic convexity trade.
Zeros in models
In short-rate models, the zero price has closed form, e.g. Vasicek/Hull–White: \(P(t,T) = A(t,T)e^{-B(t,T) r_t}\) — making zeros the analytic building block for calibrating swaptions, caps and everything above them.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Zero-Coupon Bond in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Zero-Coupon Bond beside any other instrument →
Where this instrument shows up elsewhere
- EasyWhat is a bond, in plain words?QuestionsA loan cut into tradeable pieces
- MediumA Structured Note vs. Its PartsCompareAlmost every structured product is a bond plus one or two options
- MediumWhy does a bond trade above 100?QuestionsBecause its coupon is better than what is on offer today, and the market charges for that difference up front