Question

Would you prefer a coupon bond or a zero coupon bond? Assume that both of them would yield the same return (regardless of the coupon bond's payments). Explain your answer

Answer 1

Zero coupon bonds are the bonds which are traded at a price way less than the par value and can be redeemed at par value on maturity. There are no coupon payments for Zero coupon bonds.

A zero coupon bonds will be preferred over the regular bonds with the same maturity because zero coupon bonds have higher returns because of the shape of the yield curve.

The regular coupon bonds' interest payments are due before the date of maturity, so those payments are like small zero-coupon bonds. The expected returns are reduced as the interest payments cut down the wait time and the risk.