Zero-Coupon bonds

Not too many years ago every bond had coupons attached to it. Every so often, usually every 6 months, bond owners would take a scissors to the bond, clip out the coupon, and present the coupon to the bond issuer or to a bank for payment. Those were "bearer bonds" meaning the bearer (the person who had physical possession of the bond) owned it. Today, many bonds are issued as "registered" which means even if you don't get to touch the actual bond at all, it will be registered in your name and interest will be mailed to you every 6 months. It is not too common to see such coupons. Registered bonds will not generally have coupons, but may still pay interest each year. It's sort of like the issuer is clipping the coupons for you and mailing you a check. But if they pay interest periodically, they are still called Coupon Bonds, just as if the coupons were attached.

When the bond matures, the issuer redeems the bond and pays you the face amount. You may have paid $1000 for the bond 20 years ago and you have received interest every 6 months for the last 20 years, and you now redeem the matured bond for $1000.

A Zero-coupon bond has no coupons and there is no interest paid. But at maturity, the issuer promises to redeem the bond at face value. Obviously, the original cost of a $1000 bond is much less than $1000. The actual price depends on: a) the holding period -- the number of years to maturity, b) the prevailing interest rates, and c) the risk involved (with the bond issuer).

The US Treasury also issues Zero Coupon Bonds. The ``Separate Trading of Registered Interest and Principal of Securities'' (a.k.a. STRIPS) program was introduced in February 1986. All new T-Bonds and T-notes with maturities greater than 10 years are eligible. As of 1987, the securities clear through the Federal Reserve's books entry system. As of December 1988, 65% of the ZERO-COUPON Treasury market consisted of those created under the STRIPS program.