Ask Mary Beth: Money Q & A |
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Zero-coupon bonds
What is a zero-coupon bond?
Mary Beth answers:
Zero-coupon bonds are sold at a deep discount from their par value and grow over a set period of time to reach that value. For example, a $1,000, 20-year bond at 6 percent interest sells for $312 because $312 at 6 percent compounded for 20 years equals $1,000.
While zeros are a good way to meet long-term savings goals like college or retirement funds with a relatively small initial investment, there are disadvantages. No interest is paid until the bond matures. However, tax is due each year on the "phantom" interest that accumulates even though the bond holder has received no interest payments.
Zero-coupon bonds are issued by corporations, municipalities, and federal agencies. You want to make sure that the earnings exceed both inflation and taxes to make it worth your investment.
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