A zero-coupon security, also referred to as a stripped bond is a regular coupon paying bond without the coupon.The word zero or stripped is done by a brokerage or bank; stripping the bonds then registers and trades these zeros as individual securities.To think about a zero coupon conceptually, they are just like Treasury Bills.An investor will pay a specified amount up front in exchange for a promise to receive another specified amount when the coupon matures.
Types of Zero coupon securities
There are several different kinds of zero coupons; almost as many as there are bonds.They also come in many different variations as well.Here are some different types of zero coupons:
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- Strips. Strips are zeros that are backed up by government securities and usually offered by brokerage houses.Each of the different proprietary brands of strips works in a similar way.The brokerage buys a government or a municipal security and holds them in escrow.The principal is then stripped form the interest and markets zero certificates.
- Corporate zeros.These are similar to corporate bonds, done zero style.Corporate zeros are the most risky of any type of zero security because you are buying into the credit risk of the corporation.If the issuing company defaults on the zero, the holder receives no interest whatsoever.
- – The Treasury also offers STRIPS which are separate trading of registered interest and principal securities.
- – Municipal zeros.Municipal and state governments can also issue zeros in the form of municipal bonds.These generally have a lower return be are tax free on the federal level.
- – Zero coupon convertibles.Zero coupon convertibles can be changed from zeros to other kinds of securities.
What to consider when investing in zeros
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- Since zero bonds do not feature regular interest payments they are not income investments.They should be considered an appreciation investment.
- – Remember that unlike the growth in value of a stock portfolio or mutual fund the value of a zero coupon is a representation of accrued compound interest; it is also taxed as such.
- – Zeros are not taxed as capital gains.What does that mean for a business?It means quite simply that they are taxed at higher rates.
- – Since zeros are debt instruments the risk involved depends largely on the credit strength of the issuer.
- – If you want to decrease the amount of risk involved then stick with government backed securities like U.S. Treasury bonds.Corporate bonds carry a much higher risk.
- – The real value of zeros depends on how the returns compare with the interest rates.This makes zeros very volatile and as a result most investors hold zeros until they have reached their full maturity.
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So are zero-coupon securities right for your business?Since you have several options regarding different types of zero-coupon securities it makes them a serious option for business investing.The three main uses for zero-coupon securities is capital appreciation, tax deferred savings, and predictability.The most common way to buy and sell zero-coupon securities is through full service or discount brokers, commercial banks, or other financial intermediaries.With all that in mind you should have a better idea of whether or not zero-coupon securities are right for your business or not.