Zero Coupon Bonds Essay -- essays research papers

Zero coupon bonds, more commonly known as strips or zeros, are fixed income securities that unlike another(prenominal) bonds, pay no interest until maturity. This means that instead of paying semi-annual interest like other bonds, the interest is obscureed throughout the life of the bond and is paying in full upon maturity. Zero coupon bonds are ideal long-term investments for people who have a specific situation, which calls for a specific occur of currency to be acquired at a future date, mainly ten to twenty years in the future. These bonds offer a great variety of benefits that are irresistible to investors who are looking for more of a long-term investment. They also pose a few drawbacks, but are outweighed by their advantages which make them a fail investment. Zero coupon municipal bonds combine the benefits of the zero coupon instrument with those of tax-exempt municipal securities and offer the following advantages Low Minimum InvestmentThe graduation exercise thing t hat comes to mind when investing in zero coupon bonds is its low sign investment. Zeros are sold at a deep discount relation to other bonds and therefore faecal matter be purchased with a low minimum investment. Investors purchase zeros for much less than their face value, which is typically in increments of $5000, however, zero-coupon bonds with face set of $1000 are also sold. The greater the number of years a zero-coupon bond has until maturity, the less an investor has to pay for it. The reason of such a low initial investment is another benefit of zeros, compounded interest. The small initial dollar outlay makes zeros attractive investments for many investors. It allows investors to put aside a modest amount of money today and know exactly how much they will beget at a specific future date. Tax AdvantagesAnother benefit of zero-coupon bonds is its assertable tax advantages. Interest on municipal zero-coupon bonds is exempt from federal income taxes and, in many cases, fre e from state and local taxes. Because municipal zeros offer the benefit of compound interest free from federal taxes, they provide returns that are often much higher on a net basis than comparable taxable securities. Zeros purchased earlier to April 1993 and held to maturity are not subject to capital gains tax unless they are purchased at a price lower than the compound accreted value (CAV). The sale or excha... ...e volatility of the bond. Zeros are extremely volatile investments. This means that if the interest rate changes, it can swing the price of the bond in either direction. However, this is only a problem if the bond is sold before maturity. If the bond is held to the mature date, the investor will receive the full face value. If the bond is sold before it matures, there could be a possibility that the investor could lose money. Another inconvenience that zeros offer is its possible tax charges. Although zeros dont include any coupon payments because they pay no annual in terest, the investor is still obligated to pay income tax on the interest he would of earned for the year even though he didnt receive it. Of course there are ways around this if you invest in tax-exempt municipals where there are no charges. One more drawback of zeros is that they can be callable. This means that the issuer has the right to repurchase the bond back from the investor at any time before maturity. If the issuer repays the bond at a certain percentage rate, it can potentially lose money for the investor. You would also have to pay a capital gains tax if the IRS thinks you made more than you should.