In this sub-section, we will discuss the differences between coupon and zero-coupon bonds, their characteristics, and how they are valued. Coupon bonds pay periodic interest payments to bondholders, while zero-coupon bonds do not pay any interest and are sold at a discount to their face value. The valuation of these bonds depends on factors such as interest rates, time to maturity, and credit quality.
Which of the following best describes a zero-coupon bond?
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A) A bond that pays periodic interest payments is a coupon bond. B) A zero-coupon bond is sold at a discount to its face value and does not pay interest. C) A bond that can be redeemed by the issuer before its maturity date is callable. D) A bond that can be sold back to the issuer at a specified price before its maturity date is puttable.
Which of the following factors is most important in determining the value of a zero-coupon bond?
A) Coupon rate does not apply to zero-coupon bonds, as they do not pay interest. B) Current yield does not apply to zero-coupon bonds, as they do not pay interest. C) Yield to call does not apply to zero-coupon bonds, as they do not have call provisions. D) Yield to maturity is the most important factor in determining the value of a zero-coupon bond, as it represents the total return an investor will receive if they hold the bond until it matures.
In the early 1980s, the U.S. government issued zero-coupon bonds called STRIPS (Separate Trading of Registered Interest and Principal of Securities) to help finance the federal deficit. These bonds were sold at a deep discount to their face value and only paid interest once they matured. The popularity of these bonds grew as investors sought a safe, long-term investment with a guaranteed return.
Which of the following risks is most relevant to zero-coupon bonds?
A) Interest rate risk is most relevant to zero-coupon bonds, as changes in interest rates can significantly affect their value. B) Credit risk is relevant to all bonds but not the most relevant risk for zero-coupon bonds. C) Call risk does not apply to zero-coupon bonds, as they do not have call provisions. D) Reinvestment risk does not apply to zero-coupon bonds, as they do not pay periodic interest payments.
An investor purchases a 10-year zero-coupon bond with a face value of $1,000 for $750. The investor will not receive any interest payments during the bond's life. Instead, they will receive the full face value of $1,000 when the bond matures in 10 years, earning a total return of $250.
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Example Series 65 Example Practice Question
Coupon bonds pay interest, it's plain to see, but zero-coupon bonds are sold at a discount, interest-free.
- Zero-coupon bond price quote discount: A zero-coupon bond is a bond that does not pay periodic interest payments and is issued at a discount to its face value. The bondholder receives the full face value at maturity.
- Example zero-coupon bond price: A 5-year zero-coupon bond with a face value of $1,000 is issued at a price of $800. The bondholder will receive $1,000 at the end of 5 years but no interest payments during the bond's term.