ZERO COUPON BONDS: An innovative tool to fund PSBs and keep deficit in check

ZERO COUPON BONDS: An innovative tool to fund PSBs and keep deficit in check

Subject: Economics

Context: The government has used financial innovation to recapitalise Punjab & Sind Bank by issuing the lender Rs 5,500-crore worth of non-interest bearing bonds valued at par.

Concept:

• A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value.
• Some bonds are issued as zero-coupon instruments from the start, while others bonds transform into zero-coupon instruments after a financial institution strips them of their coupons, and repackages them as zero-coupon bonds.
• Because they offer the entire payment at maturity, zero-coupon bonds tend to fluctuate in price, much more so than coupon bonds.
• A zero-coupon bond is also known as an accrual bond.
• The difference between the purchase price of a zero-coupon bond and the par value, indicates the investor’s return.