We all know how this one feels on the course, but that's not what we're going for here. When you buy a bond, it has a face value: that's the set price of the bond when it was issued. That bond will pay interest each year. Bonds trade like stocks, more or less and sometimes, the actual trading value of the bond goes up because investors are willing to pay more than the face value or par value of the bond. Why would they do that? Well, if overall interest rates have dropped, then bonds with coupon rates paying higher interest levels will be bid up. When this happens, your bond can be bid up to be selling above par.
Example: Galactic Empire incorporates and decides to issue bonds because they're in debt after building a new space station. Darth Vader decides he wants to buy a $1,000 bond. He's getting up there in years and wants to be able to enjoy his days in retirement at some point. He gets himself a 5-year bond with a 10% coupon. That means that, every year, he'll get $100 for handing over his cash, and at the end of five years, he’ll get his original $1,000 back. After two years, Darth is dreaming about what he'll do with that money if there's a disturbance in the Force. Interest rates drop. Now the same type of bond from the Empire comes with a 6% coupon because of the change. Good ol' Darth is feeling pretty smug because his bond 10% interest or $100 a year is locked in, but what happens to anyone who wants to invest now?
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Finance: What is a zero coupon bond?15 Views
Finance allah shmoop What is a zero coupon bond After
all this time our hero remains zero Yeah dude all
right well there was a whole song about him and
your parentsgeneration Just ask him The coupon on a bond
is its dividend or yield payment also known as the
rent paid by the corporation or government or individual who's
Borrowing that money sofa bond has zero coupon Does that
mean the rental of that capital is free Uh no
not at all Isiro coupon bond with par value of
a thousand might sell initially for say seven hundred twenty
dollars iy a big discount to that grand the bonds
interest is on ly paid cumulatively at the very end
when the person who loaned the seven hundred twenty dollars
gets his grand back that's it it's a one time
payment of a thousand bucks so many years later like
a decade of that bond yielding a bit over three
point three percent if you did the math of compounding
well this is what it would look like Note that
the amount owed at the end of the year is
mohr than what was owed the previous year and that
the interest is charged than on that amount Well in
real life these calculations are done twice a year with
bonds that is every six months the interest rates are
charged Zero coupon bonds yield notably more than normal bonds
which pay interests every six months Why Why With zero
coupon bonds yield mohr risk in paying some interest at
least some each six month period Well the bondholders getting
something back along the way and over time the interest
payments can be More than the principal loaned itself So
with zero coupon bonds Well there's Just a one time
payment at the very end So you'd better hope the
person showing you that money doesn't You know just decide
to skip town a week before the principal and interest
combined Or do speaking of which i've got a flight 00:02:00.288 --> [endTime] to catch No
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