A zero-coupon investment is a debt security that does not pay periodic interest, but instead is purchased at a discount and matures at face value.
A zero-coupon investment is a financial instrument—typically a bond—that does not offer interest payments (coupons) during its life. Instead, investors purchase it at a deep discount to its face value and receive the full amount (par value) at maturity. The difference between the purchase price and the maturity value represents the investor's earnings. Common issuers of zero-coupon investments include governments (e.g., U.S. Treasury) and corporations. These instruments have durations that range from short-term (like Treasury bills) to long-term maturities of 10, 20, or even 30 years. Because they don’t pay interest periodically, investors must wait until maturity to receive any returns. Zero-coupon instruments carry unique tax considerations: although investors don't receive interest payments annually, they may still owe taxes on the imputed interest (accreted value) unless they’re held in tax-advantaged accounts. They are often favored in financial planning for future liabilities—such as college tuition or charitable donations—because their maturity date and return are known upfront, making them relatively predictable.
Zero-coupon investments can be powerful tools for structuring predictable, long-term financial returns within a family office portfolio. Their discounted pricing, known maturity value, and lack of interim cash flows make them particularly useful for matching future liabilities or incorporating into a strategic asset/liability management framework. In addition, family offices often use these instruments in tax-advantaged accounts to avoid phantom income taxation, thereby preserving tax efficiency. Their valuation simplicity also assists with portfolio modeling and holistic wealth reporting.
Suppose a family office investor buys a 10-year zero-coupon bond with a face value of $100,000 for $61,000. At maturity, the investor receives $100,000, resulting in an implied yield of roughly 5% annually. This structure allows the office to time the redemption with a known future cash need, such as funding a philanthropic initiative.
Zero-Coupon Investment vs. Zero-Coupon Bond
While the terms are often used interchangeably, 'zero-coupon bond' refers specifically to a fixed-income security without periodic interest payments, whereas 'zero-coupon investment' is a broader term encompassing any non-interest-paying financial instrument purchased at a discount to face value, including T-bills, structured notes, and zero-coupon municipal bonds.
Do zero-coupon investments pay any interest?
No, zero-coupon investments do not make periodic interest payments. Instead, they are issued at a discount and mature at face value, with the return realized at maturity.
Is the interest on a zero-coupon investment taxable during the holding period?
Yes, in most cases the imputed interest is taxable annually as ordinary income even though no cash is received, unless the investment is held in a tax-deferred account like an IRA.
Are zero-coupon investments risk-free?
Not necessarily. While government-issued zero-coupon bonds (like U.S. Treasuries) carry limited default risk, others—such as corporate zero-coupon bonds—may carry credit risk. Additionally, all zero-coupon bonds are exposed to interest rate risk due to their long duration.
