A zero coupon bond is defined as adebt security that does not pay back an interest (a coupon). But it is tradedin a stock exchange at a greater discount, generating profits at the maturitywhen the bond is redeemed for its full face value. Others are bonds that arestripped off their coupons by a financial institution and resold as a zerocoupon bond.
The entire payment including the coupon at the time of maturity isoffered later. The price of zero coupon bonds have a tendency to fluctuate morethan the prices of coupon bonds (Momoh, 2018).Yield curve is obtained by plottingthe interest rates obtained from the securities against the time (monthly,daily or annually) for securities having different maturity dates.
Theseplotted data have been used in various studies to identify behavior of thesecurities and to predict the future behaviors. Various studies have beenconducted to investigate the behavior of various types of treasury bonds andbills by using the yield curve.The return oncapital invested in fixed income earning securities is commonly called as yield.The yield on any instrument has two distinct aspects, a regular income in theform of interest income (coupon payments) and changes in the market value andthe fixed income gearing securities (Thomas et al.).Durbha, Datta Royand Pawaskar in their paper titled “Estimating the Zero Coupon Yield Curve”have pointed out factors the Maturity period, Coupon rate, Tax rate, Marketabilityand Risk factor, which make a yield differential among the fixed income bearingsecurities. Further they have pointed out that the government securities whichare considered as the safest securities to invest also carries hidden risks as Purchasingpower risk and Interest rate risks.
According to theauthors the behavior of inflation within the country arises due to the purchasingpower risk and lead to changes in real rate of return. Interest rate risk is produceddue to the oscillations in prices of the securities. In such a case theinvestors should regulate their portfolios accordingly.