A zero-coupon bond is a type of bond that does not pay periodic interest (coupon) payments. Instead, it is issued at a significant discount to its face value and pays the full face value at maturity. The difference between the purchase price and face value represents the investor's return.
For example, a zero-coupon bond with a face value of $1,000 might be purchased for $800. At maturity, the investor receives the full $1,000, earning $200 in profit.
Zero-coupon bonds are ideal for long-term investors who don't need periodic income and want a guaranteed return at a specific future date. They are commonly used for retirement planning or saving for specific goals like education. However, investors should be aware that zero-coupon bonds are subject to taxation on the imputed interest, even though no cash is received until maturity.