A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

Zero-Coupon Bonds Can Generate
Large Future Returns
Suppose you were told you could invest $10,000 now and
be guaranteed by the government that you would get back
double that amount in about fifteen years. The ability to do
so is possible through the use of zero-coupon securities.

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These securities are called zero coupons or simply zeros
because owners receive no periodic interest payments, as
they do in a regular interest-coupon-paying bond. Instead,
these securities are purchased at deep discounts from their
face value (for example, 50 cents on the dollar) and gradually
rise to their face or par values over the years. If held to
maturity, the holder is paid the full stated amount of the
bond. These securities are available on maturities ranging from
a few months to over twenty years. They are excellent
vehicles for putting money aside for required expenditures on
specific future dates.
The principal attraction of zeros is that the purchaser is
faced with no reinvestment risk. A zero-coupon Treasury
bond guarantees an investor that his or her funds will be
continuously reinvested at the yield-to-maturity rate.
The main disadvantage of zeros is that the Internal
Revenue Service requires that taxable investors declare
annually as income a pro rata share of the dollar difference
between the purchase price and the par value of the bond.
This is not required, however, for investors who hold zeros in
tax-deferred retirement plans.
Two warnings are in order. High-commission brokers will

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charge small investors fairly large commissions for the
purchase of zero-coupon bonds in small denominations. In
addition, you should know that redemption at face value is
assured only if you hold the bonds to maturity. In the
meantime, prices can be highly variable as interest rates
change.