Course 204: Zero-Coupon Securities
Types of Zero-Coupon Securities
In this course
1 Introduction
2 What Are Zero Coupons?
3 Types of Zero-Coupon Securities
4 Strategic Considerations of Zero Coupon Securities
5 Zeros Are a Unique Twist on Bonds

There are as many kinds of zero-coupon securities as there are bonds, plus a number of interesting variations.

Corporate zeros: These are corporate bonds, done zero-style. Because you are buying into the credit risk of the corporation, corporate zeros are the most risky kind of zero coupon. These are even riskier than a corporate coupon bond (or registered bond), because if the issuing company defaults on the zero, the holder receives no interest at all.

Strips: Strips are zeros that are backed by government securities and offered by brokerage houses. Brokerages are proliferating their own proprietary brands of strips under a dizzying array of acronyms: TIGRs, CATS, and other species. Each has different features but works in a similar way. The brokerage buys either U.S. government or municipal securities and holds them in escrow. It then separates--strips--the principal from the interest and markets zero certificates based on one or the other. One example is the Salomon Brothers CATS (Certificate of Accrual on Treasury Securities), a zero in which the face value is based on the accrued value of the underlying Treasury securities.

STRIPS: The Treasury also offers STRIPS--which stand for "separate trading of registered interest and principal of securities"--based on Treasury bonds. Some of the venerable U.S. savings bonds are actually forms of zeros as well.

Municipal zeros: Municipal and state governments also issue zeros in the form of zero-coupon municipal bonds, which frequently have lower returns but are generally tax-free on the federal level.

Zero-coupon convertibles: Finally, zero-coupon convertible bonds can be changed from zeros to other kinds of securities. Companies may issue zero-coupon bonds that may be converted into shares of common stock in the company. Convertible municipal zeros can change from zero coupon to regular interest-paying bonds at some time before maturity.

Next: Strategic Considerations of Zero Coupon Securities >>

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