Bond Investment Strategies
Putting Compound Interest to Work
Compounding is the process by which investment interest earnings added to the investment principal form a larger base on which to accumulate additional earning.
Zero coupon bonds offer investors the opportunity to earn compound interest over the life of the bond.
With conventional bonds, the investor pays the face amount of the bond and receives interest payments every six months or a year based on the coupon, or interest rate, offered when the bond is sold. When the bond matures, the investor then is reimbursed the full principal amount invested.
When purchasing a conventional bond, you invest an amount equal to the face value of the security. As long as you own the bond, you receive regular interest payments and recoup the initial investment when the bond matures.
A zero coupon bond, on the other hand, is sold at a discount from its face value and the issuer makes no interest payments during the life of the security. When it matures, you receive the full face amount which equals your initial investment plus accumulated interest compounded over the life of the bond. This type of bond allows individuals who do not have a lot of money to begin investing and have money returned to them at the end.