Bonds are among a number of investments known as fixed-income securities.𒀰 They are debt obligations, meaning that the investor loans a sum of money (the principal) to a company or a government for a set period of t📖ime, and in return receives a series of interest payments (the yield). When the bond reaches its maturity, the principal is returned to the investor.

Making Money From a Coupon-Paying Bond

There are three ways that💦 investors can make money from bonds.

• The individual investor buys bonds directly, with the aim of holding them until they mature in order to profit from the interest they earn. They earn interest through scheduled payments (called coupons) paid out periodically until the bond matures.
• Investors can buy a basket of bonds through a bond index fund (either an ETF or a mutual fund). They can receive dividend payments from this fund, Their investment will never reach a maturation date, but they can make profit both my dividend payments and by selling their shares of the fund at a higher price than they paid for it.
• Bond investors can buy a bond at some point after its initial issue. They buy the bond though a secondary market, preferably at a lower price than par value. They then wait until the market price of bond rises, and sell the bond, profiting from the change in price as well as any coupons received while they waited.
• Professional bond traders dominate the secondary market for bonds, where existing issues are bought and sold at a discount to their face value. The amount of the discount depends partially on how many payments are still due before the bond reaches maturity. But its price also is a bet on the direction of interest rates or other market conditions. As an example, if a trader thinks interest rates on new bond issues will be lower, the existing bonds may be worth a little more.

In eit🔴her 🌳case, the owner of the bond receives interest payments, known as the coupon, throughout the life of a bond, at the interest rate that was determined when it was issued.

For instance, if you invested $1,000 in a 10-year bond with a ꦬcoupon rate of 4%, the issuer would send you a coupon (interest) payment of $40 every year. Most bonds pay twice a year, so you would receive two checks for $20 each.

Making Money From a Zero-Coupon Bond

Investors in zero-coupon bonds receive no payments for their money until the bond matures. They buy the bond for an amount that is less than its face value. When it reaches its maturity, they are paid the full face value of the bond.

Th🦩e zero-coupon bond alsoඣ is known as a discount bond. U.S. Treasury bills (T-bills) and U.S. savings bonds are two examples.

Most zero-coupon bonds have a pre-set face value and therefore pay a pre-set amount of money at maturity. Some bonds are inflation-indexed, meaning the face value is determined at maturity. The amount paid will be based on a standard measureꩲ such as the consumer price index plus a premium.

Types of Zero-Coupon Bonds

Bonds are issued with maturitꦦy dates that vary in their len🔜gth of time.

Zero-coupon bonds that are cons💞idered short-term investments typically have a maturity of no more than one year. These short-term bonds are usually called bills.

A zero-coupon bond that is a long-term investment may have a maturity date of 10 to 15 years or more.

Coupon-Paying Bond Vs. Zero-Coupon Bond

Coupon-paying bonds are a frequent choice of older investors and retirees who value the steady income that the payments provide and the relative safety of bonds as an investm💙ent.

Those short-term Treasury bills have the same benefits♚ as reliable income supplements and safe investments.

The long-term zero-coupon bond holds little attraction for most older inv🐻estors and retirees, who are unlikely to want to tie up their money for decades.

Such a long-term bond might, however, be useful as part of a young family's savings plan. It also can be used by wealthy investors as a vehicle for passing on an inheritance.

Tax Benefits of Zero-Coupon Bonds

Zero-coupon bonds♔ issued in the U.S. retain an original issue discount (OID) for tax reasons.

Zero-coupon bonds often input receipt of interest payment, or phantom income, despite the fact the bonds do not pay periodic interest. For this reason, zero-coupon bonds subject to taxation in the U.S. can be held in a tax-deferred retirement account, allowi♛ng their investors to avoid tax on future income.

If a zero-coupon bond is issued by a U.S. local or state government entity, interest is free from federal tax and generally exempt from state and local tax as well.