Add 1 to the required rate of return as a decimal.
How to Calculate Yield to Maturity of a Zero-Coupon Bond
Raise the result to the power of the number of years until the bond matures. Divide the face value of the bond to calculate the price to pay for the zero-coupon bond to achieve your desired rate of return. First, divide 6 percent by to get 0. Second, add 1 to 0. Third, raise 1.
Based in the Kansas City area, Mike specializes in personal finance and business topics. To figure the price you should pay for a zero-coupon bond, you'll follow these steps:. Tip If you'd rather not do the calculation by hand, some online calculators allow you to determine the bond price. Video of the Day.
Spot Rates, Forward Rates, and Bootstrapping
Brought to you by Sapling. Zero-coupon bonds essentially lock the investor into a guaranteed reinvestment rate. This arrangement can be most advantageous when interest rates are high and when placed in tax-advantaged retirement accounts. Some investors also avoid paying taxes on imputed interest by buying zero-coupon municipal bonds.
Present Value of Payments
They are usually tax-exempt if the investor lives in the state where the bond was issued. With no coupon payments on zero-coupon bonds, their value is entirely based on the current price compared to face value. As such, when interest rates are falling, prices are positioned to rise faster than traditional bonds, and vice versa. That can make zero-coupon bonds, especially zero-coupon Treasuries , an effective hedge for stock portfolios.
Important Differences Between Coupon and Yield to Maturity
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Related Terms Zero-Coupon Bond A zero-coupon bond is a debt security that doesn't pay interest but is traded at a deep discount, rendering profit at maturity when the bond is redeemed.