How to Determine Zero Coupon Bond Yield

When it comes to personal finance making investments for the long haul can seem a bit daunting. One way to secure your future is to invest in high grade zero coupon bounds. These are bonds that are sold at a deep discount and then mature with a one-time payment at their face value. Here's how to determine the bond yield of a zero coupon bond.

Instructions

Difficulty: Moderately Challenging

1. Look at the value of the bond when it will reach maturity. As an example let's say that you purchased a bond that will be worth $1000 in ten years.
2. Check the price that you paid for the bond. As an example let's use the model that the popular US treasury bonds follow where they are sold for half of the price. So in our example it's $500.
3. Subtract the number of years between the zero coupon bonds maturity date and the date you purchased the bond. Most bonds are sold in terms of years, so if you bought a bond on July 1, 2009, it will mature on July 1, 2019, if it a is ten year bond.
4. Divide your total return on investment ($500) by the number of years you are waiting for the zero coupon bond to mature (10.) You are left with a number of 50, which is the actual dollar amount you are making per year.
5. Divide your yearly monetary return ($50) by the total amount of money you will receive at the maturity of the zero coupon bond ($1000.) Your answer will read .05 which represents 5 percent. In our example, you are receiving a 5 percent yield. Remember that on a zero coupon bond there is only a maturity date and not annual payments. Therefore, you are technically approximating the bond yield when you figure it over a yearly basis.

Tips & Warnings

• The yield of a zero coupon bond and the risk of that same bond work in parallel proportions. This means that the higher the yield (return on investment) the riskier the bond. The lower the yield, the lower the return on investment. Look for bonds that fit your investment style along these lines. A US treasury bond is an example of a low risk slow growing bond.
• Make sure you pay proper taxes on any zero coupon bonds you are holding. Certain bonds require you to pay taxes on a yearly basis even before the bonds matures. The upside is that when the bond does mature you aren't hit with a heavier tax bill that year.