Top 10 Zero Coupon Bonds

Bonds have been a preferred form of investment in portfolios for centuries. The most common form of bonds are the most basic versions that offer an agreed-upon interest rate payment at set intervals. But have you heard of bonds that do not pay interest during the investment period? Bonds that do not pay interest during their life are known as Zero-Coupon bonds. However, a small twist comes with this that we’ll explore in detail.

This blog will help you discover zero-coupon bonds, our collection of the top 10 bonds, and their pros and cons. That being said, let’s get into it! 

What are Zero Coupon Bonds?

Zero-coupon bonds are a type of debt security that differs significantly from standard bonds. As we previously said, their main characteristic is that they do not provide periodic interest payments. They are bought at a significantly lower price than their face value, which is the amount they will reach upon maturity.

Simply put, these bonds are about buying at a discount now and profiting later. When the bond reaches its maturity date, it’s redeemed for its full face value, offering the investor a return equal to the difference between what they initially paid and this final amount.

Here are some key points to summarise the understanding of zero-coupon bonds:

• No Regular Interest: Unlike traditional bonds, zero-coupon bonds don’t pay interest regularly.
• Deep Discount Purchase: Investors buy these bonds at a price much less than their eventual payout value at maturity.
• Profit at Maturity: The main return for the investor comes when the bond matures, at which point it’s worth its full face value.
• Price Fluctuations: These bonds can experience more significant price changes than regular bonds, mainly because their value is realised fully at the end of the term.

List of Best Zero Coupon Bonds

Based on an exhaustive list of the best zero coupon bonds, we’ve chosen 10 of them with respect to issue size and maturity date. Here are our top 10 picks for the best zero-coupon bonds in India as of 2023: 

(ISIN is a globally recognised number for each security on the market.)

Who Should Consider Investing in Zero Coupon Bonds?

If you fall under any or all of these categories, investing in zero-coupon bonds would suit you. Let’s look: 

• For Specific Future Needs: Investors with a clear objective for future financial requirements should consider zero coupon bonds. These bonds can be ideal if you save for goals like a child’s higher education, a comfortable retirement, or a well-planned vacation. They provide a lump sum at maturity, matching the timing of your future needs.

• Hands-off Investment Approach: If you prefer a ‘set and forget’ strategy, zero coupon bonds might suit you. These bonds are advantageous for those who do not wish to actively follow market trends, as they do not require constant monitoring or managing.

• Portfolio Diversification: Those with portfolios heavily invested in growth instruments might find zero coupon bonds beneficial for diversification. These bonds can introduce a stable element with a guaranteed return, balancing the potential volatility of growth-focused investments.

• Long-term Financial Planning: Zero coupon bonds are particularly attractive for long-term investment strategies. They often offer more substantial discounts when held over longer durations, making them a suitable option for investors planning for the distant future.

Yield to Maturity of Zero Coupon Bonds

Yield to Maturity, or YTM is an important metric for judging the success of bonds. An essential bond market term indicates the overall rate of return expected from a bond once all future interest payments have been made. However, given that zero coupon bonds don’t give out interest payments during their life, the YTM calculation differs from coupon bonds.

Here’s the formula for calculating the YTM of Zero-Coupon bonds: 

Let’s take a closer look with an example:
Consider Aditya Birla Finance Limited’s bond. With the given formula, if we assume a face value of ₹100 and a current bond price of ₹80, with approximately 4.5 years to maturity, the Yield to Maturity (YTM) would be approximately 5.08%.
In this example, the Yield to Maturity (YTM) number of around 5.08% is the annualised return that an investor would earn if they purchased the bond at the current price of 80 and held it until its maturity date, assuming its face value is 100.

Advantages of Zero Coupon Bonds

• Higher Returns for Higher Risk: Recognizing the inherent risk due to the absence of control over funds until maturity, zero coupon bonds typically offer a higher yield, beneficial for those not requiring immediate cash flow.

• No Reinvestment Headache: Investors in zero coupon bonds bypass the reinvestment risk completely since there are no periodic interest payments to be reinvested, ensuring a fixed growth rate of the initial investment.

• Ready Market: The liquidity of zero coupon bonds is high, with a vibrant secondary market ensuring that investors can sell their bonds, often without a loss, before maturity if they wish.

• Financial Planning Tool: These bonds are perfect for planning long-term financial goals due to their predictable payout, allowing for precise alignment with future financial needs such as education or retirement funds.

Disadvantages of Zero Coupon Bonds

• Immediate Tax on Accrued Interest: Although zero coupon bonds do not distribute periodic interest, investors still face taxation on the interest accumulating each year, which can strain finances since it demands payment before the interest is physically received.

• Investment in Riskier Ventures: Entities that issue zero coupon bonds may engage in riskier projects as they are not burdened with periodic interest payments, increasing the risk for investors, especially if the issuer’s long-term viability is uncertain.

• No Regular Income Stream: The lack of periodic interest payments with zero coupon bonds excludes them from preferred investors who require a regular income to support their ongoing expenses.

Final Word

We hope our list of the top 10 zero coupon bonds has helped pave the way for easier choices in investing. Again, the choices presented are subjective based on the metrics of our choice. Make sure to do your research as well. Who knows, perhaps you outdo our list of bonds! Happy investing!

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