What is a zero coupon bond?

A zero coupon bond is defined by its unique structure of being issued at a deep discount to its face value, with the full face value being paid out at maturity. This means that investors do not receive periodic interest payments like other bonds; instead, the interest is essentially accrued over the life of the bond and is only received when the bond matures. This characteristic allows zero coupon bonds to sell for significantly less than their face value initially.

For example, an investor might purchase a zero coupon bond with a face value of $1,000 for $600. At maturity, the investor will receive the full $1,000, resulting in a profit equal to the difference between the purchasing price and the face value, which effectively acts as the interest earned on the investment.

In contrast, the other options describe bonds with different characteristics. Bonds that are issued at face value with periodic interest payments regularly distribute interest to the bondholder, while those with a fixed interest rate pay a specific interest amount annually. Bonds backed by tangible assets have security based on physical property, which is not a defining feature of zero coupon bonds. Such distinctions are critical in understanding the nature of various bond types in personal finance and investment contexts.