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 the face value paid 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 should pay today)
• \( FV \) — Face value (amount paid 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 the bond's 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 for bonds?
A: Most bonds in the U.S. pay interest semi-annually, so this convention is standard for bond valuation calculations.

Q2: How does interest rate affect bond price?
A: Bond prices move inversely to interest rates. When rates rise, bond prices fall, and vice versa.

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

Q4: Are zero coupon bonds risk-free?
A: No, they carry interest rate risk and credit risk like other bonds, though they eliminate reinvestment risk.

Q5: Why would someone buy a zero coupon bond?
A: They're often purchased for known future expenses (like college tuition) or as long-term investments at locked-in rates.