Question

Explain how the zero-coupon rate bond provides return to the investor. What are the advantages to the corporation? (LO16-2)

Short answer

The zero-coupon rate bonds are issued at a deep discount from face value, and the difference between them is the return for investors.

Also, the company does not require to pay interest on such a variety of bonds, and such a bond also smoothens the corporation’s cash inflow.

Step-by-step solution

Return generation for investors

The return generated by the investors in zero-coupon-rated bonds is the difference between the cost incurred by the investor and the face value received at the bond’s maturity.

Advantages of zero-coupon rate bond

• The corporations are not required to pay interest on a zero-coupon rate bond.
• Zero-coupon-rated bonds facilitate the immediate inflow of cash and do not require any outflow before maturity.
• The corporations may amortize the difference between initial bond price and maturity value throughout the life of the bond.