What is a zero coupon municipal bond?

Zero coupon municipal bonds (“zeros”) are tax-exempt, intermediate- to long-term bonds purchased at a deep discount. They do not make periodic coupon interest payments. Instead, interest compounds semi-annually at a rate specified at purchase. The difference between purchase price and face amount equals this interest.

What is a zero coupon municipal bond?

Zero coupon municipal bonds (“zeros”) are tax-exempt, intermediate- to long-term bonds purchased at a deep discount. They do not make periodic coupon interest payments. Instead, interest compounds semi-annually at a rate specified at purchase. The difference between purchase price and face amount equals this interest.

What is the primary benefit of a municipal zero-coupon bond?

Zero-coupon municipal bonds provide investors with the opportunity to lock in a specified rate of return, without having to worry about reinvestment risk or future interest rate changes.

What do zero-coupon bonds do?

A zero-coupon bond is a debt security instrument that does not pay interest. Zero-coupon bonds trade at deep discounts, offering full face value (par) profits at maturity. The difference between the purchase price of a zero-coupon bond and the par value indicates the investor’s return.

What is the primary benefit of a municipal zero-coupon bond quizlet?

What is the benefit of a zero coupon bond? Zero coupon bonds do not make period payments. The bond is purchased at a deep discount price and builds internally until maturity, at which point the bond is redeemed at par.

Do you pay tax on a zero coupon bond?

In addition, although no payments are made on zero coupon bonds until they mature, investors may still have to pay federal, state, and local income tax on the imputed or “phantom” interest that accrues each year.

How often is the interest income on zero coupon bonds taxed?

each year
In a rising interest rate environment, their value is likely to fall more than other bonds. Zero coupon bonds are subject to an unusual taxation in which the receipt of interest is imputed each year, requiring holders to pay income taxes on what is called “phantom income.”

Why would a company issue zero-coupon bonds?

After 20 years, the issuer of the bond pays you $10,000. For this reason, zero-coupon bonds are often purchased to meet a future expense such as college costs or an anticipated expenditure in retirement. Federal agencies, municipalities, financial institutions and corporations issue zero-coupon bonds.

What is a major advantage to government and municipal bonds?

Municipal bonds offer flexible options and are also tax free. The greatest advantage of municipal bonds can be summed up in two words: tax free. The interest rates on municipal bonds may seem low compared to similar long-term securities like Treasury bills and CDs, but tax advantages may level the playing field.

What is one major advantage that municipal bonds have over other types of bonds?

Investing in municipal bonds is a good way to preserve capital while generating interest. Most of them are exempt from federal taxes, and some are tax-free at the state and local level as well.

Are zero-coupon bonds riskier?

Unique Risks of Zero-Coupon U.S. Treasury Bonds Treasury zeros can fall significantly if the Fed raises interest rates. Finally, Treasury zeros face a high risk from inflation.

Why do zero-coupon bonds have high risk?

Zero coupon bonds are more sensitive to interest rate swings than bonds which pay interest semiannually because all the interest payments of zero coupon bonds are accumulated and paid at maturity.