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A zero coupon bond is defined as a
debt security that does not pay back an interest (a coupon). But it is traded
in a stock exchange at a greater discount, generating profits at the maturity
when the bond is redeemed for its full face value. Others are bonds that are
stripped off their coupons by a financial institution and resold as a zero
coupon bond. The entire payment including the coupon at the time of maturity is
offered later. The price of zero coupon bonds have a tendency to fluctuate more
than the prices of coupon bonds (Momoh, 2018).

Yield curve is obtained by plotting
the interest rates obtained from the securities against the time (monthly,
daily or annually) for securities having different maturity dates. These
plotted data have been used in various studies to identify behavior of the
securities and to predict the future behaviors. Various studies have been
conducted to investigate the behavior of various types of treasury bonds and
bills by using the yield curve.

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The return on
capital invested in fixed income earning securities is commonly called as yield.
The yield on any instrument has two distinct aspects, a regular income in the
form of interest income (coupon payments) and changes in the market value and
the fixed income gearing securities (Thomas et al.).

Durbha, Datta Roy
and Pawaskar in their paper titled “Estimating the Zero Coupon Yield Curve”
have pointed out factors the Maturity period, Coupon rate, Tax rate, Marketability
and Risk factor, which make a yield differential among the fixed income bearing
securities. Further they have pointed out that the government securities which
are considered as the safest securities to invest also carries hidden risks as Purchasing
power risk and Interest rate risks.

According to the
authors the behavior of inflation within the country arises due to the purchasing
power risk and lead to changes in real rate of return. Interest rate risk is produced
due to the oscillations in prices of the securities. In such a case the
investors should regulate their portfolios accordingly.

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