Zero-Coupon bond: Definition, how it works and how to calculate

3 min read | Updated on October 09, 2025, 18:31 IST

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When companies and governments require extra funds to meet their capital expenses, they can issue bonds. Investors with a low risk appetite looking for a secure investment for capital appreciation often go for bonds. Most bonds carry interest, I.e, Coupon, but some don’t. Bonds that don’t pay interest are called ‘Zero-Coupon Bonds’.

In this blog, you will understand what zero-coupon bonds are, how they work, and how to price a zero-coupon bond.

What is a zero-coupon bond?

Zero-coupon bonds are debt instruments that carry zero interest. When a company wants to issue bonds without having to pay interest, it issues zero-coupon bonds. These bonds are sold to investors at a lower price than their face value. No interest is paid to investors, but at maturity, the company pays the real face value to the investor. The difference between the purchase price and the full face value received at maturity is the profit.

How does a zero-coupon bond work?

Zero-coupon bonds carry zero interest, and the profit is the difference between the purchase price and the total face value received at maturity of the bond.

Let’s understand this with a simple example,

Company A issues zero-coupon bonds at a face value of ₹100 with a tenure, I.e, maturity of 2 years. The company sells the bond at a discounted price of ₹90. The investor buys the bond at ₹90 and holds the bond till maturity. At maturity, Company A will pay the investor ₹100 on the bond, providing a profit of ₹10 to the investor.

How to price a zero-coupon bond?

To determine the price of zero-coupon bonds, you can use the following formula.

Price = Face value / (1 + YTM) ^Number of years

For example, Company B issues a zero-coupon bond at a face value of ₹1000, with a yield to maturity (YTM) of 6% for a tenure of 15 years.

Therefore,

Price of zero coupon bond = 1000 / (1+ 0.06)^15 = 417.265

Meaning, today you can purchase the bond at ₹417 (approx) and after 15 years get ₹1000, making a profit of ₹583.

Advantages of investing in zero-coupon bonds

Here are the advantages of investing in zero-coupon bonds,

Lower risk

Bonds carry lower risk compared to equities. Hence, risk-averse investors prefer zero-coupon bonds.

Higher return than regular bonds

Zero-coupon bonds can potentially give higher returns than regular bonds, as you can purchase them at a discounted rate and receive the full face value at maturity.

Predictable future return

With zero-coupon bonds, you know while buying the bond, what return you can expect at the end of maturity.

Portfolio diversification

Many investors invest in zero-coupon bonds to diversify the risk of their portfolio. Having a diversified portfolio reduces the total risk faced by investors.

Risks of investing in zero-coupon bonds

Before investing in zero-coupon bonds, know the following risks related to them.

Inflation risk

Inflation is when the purchasing power of your money decreases. If you invest in a bond that gives you ₹1000 at maturity, that ₹1000 will not hold the same value it does today.

Liquidity risk

Liquidity means the ability of an instrument to be converted into cash. Zero-coupon bond carries significant liquidity risk. If you need urgent cash, you may face difficulty in selling the bond and might have to sell at a lower price than what you paid.

Credit risk

Credit or default risk means the risk of a company defaulting on bonds issued. If the company is unable to pay the bond face value at maturity, then you will face a loss.

One-time return

Zero-coupon bonds don’t pay regular interest, they give you a one-time return at maturity. Hence, zero-coupon bonds are not suitable for investors looking for regular fixed income generated by regular bonds.

Zero-coupon bonds are a simple investment for investors with specific goals, for example, for retirement, children’s education, or marriage. To become a smart investor, sign up on UpLearn by Upstox today!

About Author

Mariyam Sara

Sub-Editor

holds an MBA in Finance and is a true Finance Fanatic. She writes extensively on all things finance whether it’s stock trading, personal finance, or insurance, chances are she’s covered it. When she’s not writing, she’s busy pursuing NISM certifications, experimenting with new baking recipes.