What Is a Zero-Coupon Bond? Example

What is a zero-coupon bond

A zero-coupon bond is a bond that pays no periodic interest (no coupons). It is sold below its face value, and the holder receives the full face value at maturity.

The investor's return is the gap between the purchase price and the face value. A regular coupon bond pays interest along the way. A zero-coupon bond pays everything in one amount at the end.

A bond with a 5% coupon: when market yields rise, its price falls, and a longer bond moves much more than a short one. Illustrative example: made-up numbers for learning, not real prices or a broker's conditions.

Formal definition

For experienced readers: a zero-coupon bond is a single-cash-flow debt instrument. Its present value is the face value discounted at the market yield for the time left to maturity. Because there is only one cash flow, its yield to maturity equals the spot rate for that maturity. This is why zero-coupon prices are used to build yield curves.

Zero coupon bond formula

Use these symbols:

P is today's price.
F is the face value paid at maturity.
n is the number of years to maturity.
g is the growth factor for one year at the market yield. It is the amount one rupee grows to over a year at that yield.

P = F ÷ gⁿ

A higher yield or a longer maturity makes the price lower, so the discount from face value becomes larger.

Zero coupon bond example (hypothetical)

Suppose an investor buys a zero-coupon bond for price P with face value F and maturity in n years.

At purchase: the investor pays P, which is less than F.
During the life of the bond: the investor receives no payments.
At maturity: the issuer pays F.
Return: F − P, assuming the issuer does not default.

To see the annual rate this works out to, compare the gain with the time held. See annualized return and CAGR. To work with real figures, use the tools on the calculators page.

Where you see the term

Government bills. Short-term treasury bills, including Pakistan's market treasury bills, are discount instruments. They work like zero-coupon bonds. Results are published after each bond auction.
News and reports. Yields on discount instruments move with policy expectations. For example, reports have covered this SBP decision: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). Changes are often quoted in basis points.
Brokerage statements. Holdings may show an "accreted" value. This is the price moving up towards face value as maturity gets closer.

Edge cases and details

Duration. The duration of a zero-coupon bond equals its maturity. That makes its price more sensitive to rate changes than a coupon bond with the same maturity.
No reinvestment risk. There are no coupons to reinvest, so the yield at purchase is locked in if the bond is held to maturity.
Accrued interest. Zero-coupon bonds are usually priced without accrued interest. Some tax systems still treat the yearly accretion as taxable income.
Quoting conventions. Bills are often quoted as a discount rate, not a yield. The two rates are not the same number, so check which one a quote uses.
Stripped bonds. Zero-coupon bonds can be created by separating the coupons from the principal of a regular bond.
Credit risk. All the value comes at the end. If the issuer fails, nothing has been received along the way, so credit spreads matter.
Islamic finance. The discount reflects interest. Readers who follow Islamic principles can see Islamic finance.

Frequent questions

What is the zero coupon bond meaning in simple words?

It is a bond you buy below its face value. It pays you nothing until maturity and then pays the full face value.

Why is it sold at a discount?

The discount is the investor's interest. Without coupons, the discount is the only source of return.

Is a treasury bill a zero-coupon bond?

It works the same way. It is issued at a discount and repaid at face value, with no coupons in between.

Can I lose money on a zero-coupon bond?

Yes. If you sell before maturity after rates have risen, the price may be below what you paid. If the issuer defaults, you may not receive the face value.

Zero-coupon bond