Solution

The bonds that do not provide any periodical payments as cash inflows but only redeemed at face value at the end of its maturity are zero coupon bonds. The implicit interest rate which is earned on these bonds is the difference between the price (issued at a discount) at which it is issued and the face value (generally redeemed at FV). Also, known as “Deep Discount Bonds”. Also, majorly the government issued money market securities, known as “Treasury Bills” are of Zero Coupon nature. For Ex., the short-term debt instrument, issued by the government of India known as treasury bills, are issued at a price which is less than the face value. These are a type of Zero-Coupon Bonds. A treasury bill having maturity of 91 days is issued at 98 having face value of 100. Explicitly there is no cash inflows for recovery of interest payments but the holder implicitly gets an interest rate of (100-98)/98 on a 91-day basis or (100-98)/98*(365/91) on an annual basis.