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‘Zero coupon bonds’

  • Category
    Economy
  • Published
    6th Jan, 2021

The government has used financial innovation to recapitalise Punjab & Sind Bank by issuing the lender Rs 5,500-crore worth of non-interest bearing bonds valued at par.

Context

The government has used financial innovation to recapitalise Punjab & Sind Bank by issuing the lender Rs 5,500-crore worth of non-interest bearing bonds valued at par.

About

  • A zero coupon bond is a type of fixed income security that does not pay any interest to the bondholder. It is also known as a discount bond.

Coupon

  • A coupon is an interest the bond issuer pays the bondholder.
  • Coupon payments happen periodically from the time of issuance of the bond until its maturity.

They are long term debt instruments. 

  • These bonds come with 10-15 years maturity. At the time of maturity, the investor is paid the face value or par value.
  • These bonds are issued at a discount to the face value. In other words, it trades at a deep discount.
  • The return an investor earns is the principal amount plus interest amount. The interest gets compounded semi-annually.

Price of Zero Coupon Bond calculated annually

Face Value / (1 + r) n = price of bond

  • Face value = Future value or maturity value of the bond
  • r = Required rate of return or interest rate
  • n = Number of years until maturity

Who can invest?

  • These recapitalisation bonds are special types of bonds issued by the Central government specifically to a particular institution.
  • Only those banks, whosoever is specified, can invest in them, nobody else. It is not tradable, it is not transferable.

Advantages of investing

  • Significant returns on maturity
  • Fixed interest
  • Long investment horizon

Limitations of investing

  • No regular income
  • Interest rate risk
  • Illiquidity in the secondary market
  • Duration risk
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