Zero-Coupon Bonds

How Do Zero-Coupon Bonds Work?

These bonds are issued at a price lower than their face value. At maturity, the investor receives the full face value. The difference between the purchase price and the maturity amount is the return. There are no interest payouts during the holding period.

For example, you might buy a bond for ₹4.55 lakhs today and receive ₹7 lakhs at maturity 10 years later. There are no reinvestment worries, as you get a lump-sum payout.

Who Issues Them?

Zero-coupon bonds are issued by both the government (like the RBI through certain long-tenure instruments) and corporate entities such as REC. Government options are safer, while corporate bonds offer slightly higher returns but come with credit risk.

Yield to Maturity (YTM)

YTM is the annualised return you earn if you hold the bond till maturity. The formula is:

YTM = (Face Value / Price)^(1 / Years) − 1

This helps you compare different bond options over various durations.

Benefits of Zero-Coupon Bonds

• Guaranteed Lump-Sum: You know exactly how much you will get at maturity.

• No Reinvestment Risk: Since there are no interest payouts, you are not affected by changing interest rates during the bond’s life.

• Ideal for Long-Term Goals: These bonds work well for 10 to 15-year goals like higher education or retirement.

• Taxation: If held for more than three years, the gains are taxed as long-term capital gains at 20% with indexation.

• Government-Backed Safety: Bonds issued by the RBI or central agencies carry minimal default risk.

Challenges to Consider

• Interest Rate Sensitivity: Prices of zero-coupon bonds drop sharply if interest rates rise. For instance, a ₹25,000 bond might be worth ₹20,991 at a 6% yield but only ₹18,783 at a 10% yield.

• Liquidity Risk: If you try to sell the bond before maturity, you may not get the full value in the secondary market.

• Credit Risk: Corporate bonds must be evaluated for credit quality before investing. A low-rated issuer increases the risk of default.

Conclusion

In 2025, zero-coupon bonds remain a solid choice for disciplined investors who want capital protection and long-term growth. They offer clarity, simplicity, and predictability—key ingredients when planning for major life goals. Just be mindful of interest rate movements and stick to high-quality issuers if safety is your priority.