Question

5) A zero-coupon bond:

A. typically trades at a discount to face value

B. would trade at a premium to face value in the rare circumstances that the bond has a negative yield

C. both (A) and (B) are true.

D. none of the above

Answer 1

A zero coupon bond pay no coupon and issued at amount less than face value. Zero coupon bond is issued typically at discount to face value. That's why it is generally traded at discount to face value.

Value of zero coupon bond = Face value or redemption value / (1+Yield)^n

Assume, face value = $1000, n or year = 1, Yield = 10%

Issue price or traded price shall be = 1000/(1+10%)^1

$909.0909

So, Typically zero coupon bond trades at discount to face value. Option A is true and correct.

In extreme rare situation if yield is negative yield, bond may have traded at premium to face value.

Assume face value = $1000. n =1. yield = -1%

So traded price = 1000/(1+(-1%))^1

$1010.10101

So, zero coupon bond would trade at a premium to face value in the rare circumstances that the bond has a negative yield. So option B is also correct.

Answer is C. Both A and B are true.