Zero Coupon Loan Agreement
Dan buys a 10-year bond with a face value of 1,000 with semi-annual coupons of 9% for 925. It is able to reinvest its coupon payments at a nominal interest rate of 7% semi-annually. Investors have the opportunity to jump into action and make money with zero-coupon mortgages and bonds. These investments are popular with some investors, partly because of their availability in some real estate markets and also because zero-coupon bonds are sold at a discount to the face value of the note. In Canada, investors can purchase bundles of band bonds so that the cash flows of a single security are tailored to their needs. These packages may consist of a combination of interest (coupon) and/or main bands. Since the lender only receives the total interest plus the repayment when the loan is due, the credit risk is significantly higher than with a conventional loan. As a result, lenders typically only offer this form of financing to established commercial borrowers with their own credit records. They also tend to charge a higher interest rate on zero-coupon mortgages to make up for the lack of immediate returns. All this changes when his 20 years are over. Suddenly, ABC has to repay the $400,000 borrowed at a time, as well as the compound interest on the loan, or refinance itself at the applicable interest rates. If you don`t, it will cause him to lose ownership and force him to hand over the keys to the lender.
In the United States, a zero-L coupon bond benefits from an initial issue discount (OID) for tax purposes.  Instruments issued with OID typically involve the receipt of interest, sometimes referred to as phantom income, even if the bonds do not pay periodic interest.  The yield on zero-coupon bonds is 1.5% and you have $400,000 to invest, $250,000 in 2-year bonds and $150,000 in 5-year bonds. If both types of bonds have a face value of $1,000, how many bonds of each type can you buy? Zero-coupon bonds do not pay interest in cash. They are sold at a discount to offer interest to the buyer. The price of the bond is determined by determining the present value of the required cash flows using the effective interest rate negotiated by both parties. The present value represents the principal of the debt, all future interest near that date having been mathematically suppressed. The bond is recorded in this capital.
Interest is then determined for each period on the basis of the effective interest rate. Since no cash interest is paid, the entire amount recorded as interest must be added to the principal. The linear method can also be used to capture interest if the figures obtained do not differ significantly from the effective rate method. This alternative allocates an equal amount of the discount to the interest for each period over the term of the bond. Consider two 30-year bonds with the same purchase price. Each has an annual coupon of 5%, which is paid semi-annually, and a face value of 1,000. (4.29), the duration corresponds to the negative of its remaining maturity before maturity. Equation (4.27) gives the price estimate after deferral dr: Commercial projects use zero-coupon mortgages when cash flows for debt service are unlikely to be available until the project is nearing completion. An example of this would be a sports stadium. In this case, no income is generated until the structure is completed and events can take place. A futures contract is a purchase, sale or loan that takes place in the future, but with terms agreed today.
Figure 3.19 shows a cash flow pattern typical of a futures contract. They invest $130,000 in 5-year zero-coupon bonds with a yield of 1.5% and a face value of $1,000. In most countries, strip bonds are mainly managed by a central bank or central securities depository. .