A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value. A zero-coupon bond is also known as an accrual bond.

Some bonds are issued as zero-coupon instruments from the start, while others bonds transform into zero-coupon instruments after a financial institution strips them of their coupons, and repackages them as zero-coupon bonds.

Formula of Zero Coupon bond: Price= F / (1 + r)ⁿ

F= face value of the bond, R= rate of interest, N= number of years until maturity

Example- A person is looking to purchase a zero-coupon bond with a face value of Rs 1,000 and 5 years to maturity. The interest rate on the bond is 5% compounded annually. What price will that person pay for the bond today?

Price of bond = Rs 1,000 / (1+0.05)⁵ = Rs 783.53

The price that person will pay for the bond today is Rs 783.53.