The less you pay for a zero coupon bond, the higher the yield. Zero coupon bonds are issued by the Treasury Department, corporations and municipalities. The bonds are considered a low-risk investment compared to stocks, commodities and derivatives.
Characteristics of Zero Coupon Municipal Bonds
Purchase Treasury zero coupon bonds if you want the best chance of having your principal and interest paid at maturity. Treasury zeros carry a lower interest rate than municipal zero coupon bonds and corporate zero coupon bonds, but they are backed by the full faith and credit of the United States. Many investors believe the safety inherent in the bonds makes up for the lower interest rate.
The bond interest income is taxed at the federal level and possibly at the state level. Consider corporate zero coupon bonds if you are looking for high interest rates and can stomach the higher risk of default. Many corporate zeros have call provisions that allow the company to call in the bond issue before the maturity date. The interest income after taxes might equal or be less than the interest paid on municipal zeros.
Zero-coupon bond
Research municipal zero coupon bonds before you buy. Generally, municipalities with low credit ratings have to issue their bonds at a higher interest rate to attract buyers. Also consider how long you want to own the bond.
Municipal zeros pay a higher interest rate the longer you hold them, and it can take as little as one year or as long as 40 years for the bond to mature. Municipal zeros have a lower interest rate than corporate zeros. But their income is exempt from federal and, in some cases, state and local taxes. Contact your bank or broker with your zero coupon bond order. The bond selling price remains the same no matter who places your order, but keep in mind that a commission will be added to the bond purchase price.
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Use a discount broker instead of a full service broker to get a better rate on your commission fee. Based in St. In contrast, taxable zero coupon bonds are taxed each year on the amount of interest that has accrued for that year even though the accrued interest is not actually paid to investors in that year. Because they are sold at a substantial discount from face amount, you can purchase more zero coupon bonds for your money than other types of bonds.
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The greater the number of years a zero coupon bond has until maturity, the less you have to pay for it. Zero coupon bonds allow investors to invest a modest amount of money today and know exactly how much money they will receive on a specified future date. Zero coupon municipal bonds provide investors with the opportunity to lock in a particular rate of return, without having to worry about reinvestment risk or interest rates in the future. Investors in securities that pay interest semiannually may not always achieve a total realized compounded yield equal to the quoted yield to maturity they expected when they purchased their holdings.
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Depending on future prevailing interest rates, their interest payments may be reinvested in lower or higher yielding vehicles. There are zero coupon municipal bonds available with maturities ranging from one to 40 years, with the majority of these bonds having maturities between eight and 20 years.
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Some zero coupon municipal bonds carry insurance and are rated AAA.