1. What is a Zero Coupon Bond?

A zero coupon bond is a debt security that doesn't pay periodic interest but is issued at a discount to its face value. The bond's return comes from the difference between its purchase price and its face value at maturity.

2. How Does the Calculator Work?

The calculator uses the zero coupon bond formula with semi-annual compounding:

Where:

• \( PV \) — Present value (price you pay today)
• \( FV \) — Face value (amount received at maturity)
• \( r \) — Annual interest rate (as decimal)
• \( n \) — Years to maturity

Explanation: The formula accounts for semi-annual compounding by dividing the annual rate by 2 and doubling the number of periods.

3. Importance of Present Value Calculation

Details: Calculating the present value helps investors determine the fair price to pay for a zero coupon bond based on current market interest rates and time to maturity.

4. Using the Calculator

Tips: Enter face value in dollars, annual interest rate as a percentage (e.g., 5 for 5%), and years to maturity. All values must be positive numbers.

5. Frequently Asked Questions (FAQ)

Q1: Why use semi-annual compounding?
A: Most bonds in the U.S. pay interest semi-annually, so this convention is standard for bond calculations.

Q2: How does interest rate affect bond price?
A: Higher interest rates result in lower present values, and vice versa. This inverse relationship is fundamental to bond pricing.

Q3: What's the difference between annual and semi-annual compounding?
A: Semi-annual compounding results in slightly higher effective yields because interest is compounded more frequently.

Q4: Are zero coupon bonds taxable?
A: Yes, in most jurisdictions, the imputed interest is taxable annually as it accrues, even though no cash payment is received.

Q5: Where are zero coupon bonds commonly used?
A: They're popular for long-term goals like college savings (e.g., STRIPS in the U.S.) or retirement planning due to their predictable payout.