Zero-Coupon Bond Calculator

A zero-coupon bond (such as a US Treasury STRIPS or corporate zero) is a fixed-income debt instrument that pays zero periodic coupon interest payments throughout its life. Instead of distributing annual or semi-annual checks, zero-coupon bonds are issued at a deep discount to their face (par) value and mature at full face value on a specified future date.

The pricing formula for a zero-coupon bond is the pure mathematical present value of a single future cash flow: ( P = frac{F}{(1 + r/m)^{m times t}} ), where ( F ) is the face value, ( r ) is the annual yield to maturity, ( t ) is years to maturity, and ( m ) is compounding frequency (in the US market, Treasury STRIPS are priced using semi-annual compounding, ( m = 2 ), to match coupon Treasury bonds).

Because zero-coupon bonds make no intermediate coupon payments, they eliminate reinvestment risk—the risk that intermediate coupon payments will have to be reinvested at lower prevailing interest rates. For this reason, zero-coupon bonds are widely used by pension funds and individuals to lock in guaranteed compound yields for specific future liabilities, such as college tuition or retirement dates.

However, investors must beware of "Phantom Tax" (Original Issue Discount - OID). Under IRS regulations, the annual accretion of discount value is treated as taxable ordinary income each year, even though the investor receives zero cash until the bond matures. Holding zero-coupon bonds inside tax-advantaged accounts like traditional or Roth IRAs completely eliminates this phantom tax issue.