Zero Coupon Bond
A zero coupon bond is a debt instrument that pays no periodic interest (coupon). Instead, it is issued at a price significantly below its face value and redeems at full face value at maturity — the difference is your return.
Example: A zero coupon bond with a face value of ₹1,000, maturing in 5 years, might be issued at ₹747. You invest ₹747 today and receive ₹1,000 at maturity. No interest along the way — your entire return comes from the price appreciation.
How zero coupon bonds work
Regular bonds pay coupons (interest) periodically and return the face value at maturity. Zero coupon bonds skip the coupons — the entire return is embedded in the discount at which they are issued. The implied yield is the internal rate of return between the issue price and the face value over the tenure.
Zero coupon bonds are especially sensitive to interest rate changes because all cash flow is at maturity. A small shift in rates causes a larger price change compared to coupon-paying bonds of the same duration.
Examples of zero coupon instruments in India
91-day, 182-day, and 364-day government instruments issued at a discount, redeemed at face value. The most common zero coupon instruments in India.
The cumulative variant pays all interest at maturity rather than periodically — functionally similar to a zero coupon structure.
Some corporates and NBFCs issue zero coupon debentures. Higher yield than government equivalents but carry credit risk.
Tax treatment in India
The discount on a zero coupon bond (face value minus purchase price) is treated as interest income and is taxable as per your income tax slab, not as capital gains — even though no cash is received until maturity. This accrual taxation can be a cash flow concern for individual investors, as tax is due before you actually receive the money.
However, for listed zero coupon bonds held over 12 months, gains may be treated as LTCG in some structures — consult a tax adviser for your specific instrument.
Deep discount issue
Issued well below face value; the difference represents your return over the tenure.
No interim cash flows
Ideal for goal-based investing where you need a lump sum at a specific future date.
High rate sensitivity
Price moves sharply with interest rate changes due to no coupon cushion.
Who should consider zero coupon bonds
- Investors with a specific future goal (child's education, retirement corpus) who want a locked-in return.
- Those who do not need interim cash flows and prefer a clean, predictable maturity amount.
- Investors comfortable with interest rate risk over a longer tenure.
- Not ideal for those in high tax brackets due to accrual taxation without interim cash receipts.