By zero coupon bonds you can pay tax on earned interest and it can be a good idea in the right situation.
Zeros or zero coupon bonds don’t support regular interest payments as other brands do. When your bones get mature you are able to get all the interest amount lump sum.
When you buy the zero coupon bond at a very much discounted price and at its maturity you redeem it at the full current face value. This difference of price is called interest that you earned during the years.
Usually zero coupon bonds maturity time period is between 1 to 40 years.”Treasury issues” that are issued by the United State of America are popular along with corporations and municipalities.
Zero coupon bonds have the following characteristics:
• Issued at discounted price and returned at full current face value
• Before maturity some bond issuers can call zeros
• Until maturity , tax on interest must be paid annually
• These bonds are volatile as compared to regular bonds
The United States Treasury is not eligible to issue them directly, only qualified brokers or financial institutions can sell “STRIPS”. (Separate Trading of Registered Interest and Principal of Securities). It means the United States Treasury issue has been taken by a financial institution and divided the interest as well as principal payments into two split securities.
Package of normal income is prepared and sold to those investors who want a trustworthy cash flow as well as the principal turn into a zero coupon bond.
Credit & Full Faith
Though you purchase the STRIP (other names are also used ) from financial institutions and brokers, they bear the full faith.
Zero coupon bonds are also issued by municipalities and corporations. These coupon bonds have similar basic features .They sold at a sharply discounted price and cashed after some time at current full face value.
On the other hand , a few of these issues could have some cool features that allow the issuer to turn them into cash before maturity. Before investing , make sure these provisions.
There is no federal income tax on municipal zero coupon bond and regular municipal bonds.
Risk of Default
The main credit agencies give rating to most of zero credit bonds worthiness for credit. However this rating might change during the period of the bond, and price can be affected by it.
There is the most threat of default commercial zero coupon bonds but they carry higher yields and have call provisions.
What Would be the ratio of discount
The United States Treasury presented this example:
For instance the yield of three STRIPS in the market is 6.50 percent.
• STRIPS that maturity period is remaining 25 years , the price could be $ 202.07 per $ 1000 face sum.
• STRIPS that maturity period is remaining 10 years , the price could be $ 527.47 per $ 1000 face sum.
• STRIPS that maturity period is remaining 2 years cost is $879.91 per $1000 face sum.
So, you can see , that if you invest for a long time the front-end cost would decrease.
It is recommended to you that buy coupon bond on very much discounted price to face value.
In most of the cases you are liable to pay taxes annually , that make your investment safe.