Zero Coupon Bond

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.1 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.

Zero Coupon Bond- Key Features:

• A zero-coupon bond is a debt security instrument that does not pay interest.
• Zero-coupon bonds trade at deep discounts, offering full face value (par) profits at maturity.
• The difference between the purchase price of a zero-coupon bond and the par value, indicates the investor’s return.

What kind of bonds are these?:

• Recapitalisation bonds which carried interest and were sold to different banks, these “non-interest bearing, non-transferable special GOI securities” have a maturity of 10-15 years and issued specifically to Punjab & Sind Bank.
• “These recapitalisation bonds are special types of bonds issued by the Central government specifically to a particular institution.
• Only those banks, whosoever is specified, can invest in them, nobody else. It is not tradable, it is not transferable. 
• It is limited only to a specific bank, and it is for a specified period … it is held at the held-to-maturity (HTM) category of the bank as per the RBI guidelines.
• Since it is held to maturity, it is accounted at the face value (and) no mark-to-market will be there. So these are special kind of bonds issued by the government after proper (due diligence),” 
• Though zero coupon, these bonds are different from traditional zero coupon bonds on one account — as they are being issued at par, there is no interest; in previous cases, since they were issued at discount, they technically were interest bearing.
• “Now these are made zero coupon and besides that there is no difference, the said amount will be paid on the maturity as per the government notification … There is no coupon, it is zero coupon, it is issued at par and will be paid at the end of the specified period,” .
• A senior Finance Ministry official explained that while accounting of these bonds is at par, effectively it’s the net present value of the instrument which matters.
• “These are instruments which are a variation of the recap bonds but effectively meet the same purpose, and these are issued in conformity with the RBI guidelines,” .

How do they differ from zero coupon bonds issued by private firms?:

• Zero coupon bonds by private companies are normally issued at discount, but since these special bonds are not tradable these can be issued at par.
• “There is a difference between zero coupon bonds issued by other corporates and these. normally zero coupon bonds are issued at a discount, which are tradable also. 
• Here, there is no question of trading and these are special types of bonds, which the government issues specifically to a specified person and it’s issued at par,” 
• While praising the government’s move to inject equity in banks, two top finance industry executives, who wished not to be named, said that this move buys times but doesn’t solve the problem permanently.
• “It is a great innovation by the government where it is using Rs 100 to create an impact of Rs 200 in the economy. 
• It is issuing a zero coupon bond aggregating to Rs 5,500 crore at par to Punjab & Sind Bank that will mature in tranches between 2030 to 2035. 
• The market value of this bonds would be around Rs 2,750 crore. Punjab & Sind Bank, by investing in these bonds from held-to-maturity category, won’t have to book mark-to-market loss and will value the bonds at cost, i.e. Rs 5,500 crore. 
• The government will infuse Rs 5,500 crore into equity capital of Punjab & Sind Bank,”.
• By doing so, the capital adequacy of Punjab & Sind Bank goes up by Rs 5,500 crore (instead of Rs 2,750 crore).
• “While this is a financial illusion, finally the government has realised that it is better to do what Western countries are doing rather than what their academicians are recommending us. 
• One must remember that financial illusion buys you time to put your house in order. It doesn’t solve the problem permanently but gives you more time to solve it,”