Multiple Choice
Which of the following best describes the primary difference between an original issue discount (OID) bond and a zero coupon bond?
11. Long Term Liabilities
Zero Coupon Bonds
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Which of the following is true of zero coupon bonds?
A
They pay interest annually at a fixed coupon rate.
B
They do not pay periodic interest but are issued at a discount and redeemed at face value at maturity.
C
They are always issued at their face value.
D
They pay interest only at the time of issuance.
Verified step by step guidance1
Understand the concept of zero coupon bonds: Zero coupon bonds are a type of bond that does not pay periodic interest (coupon payments). Instead, they are issued at a discount to their face value and redeemed at their full face value upon maturity.
Compare zero coupon bonds to regular bonds: Regular bonds typically pay interest periodically (e.g., annually or semi-annually) at a fixed coupon rate. Zero coupon bonds differ because they do not have these periodic interest payments.
Analyze the statement 'They pay interest annually at a fixed coupon rate': This is incorrect because zero coupon bonds do not pay periodic interest.
Evaluate the statement 'They do not pay periodic interest but are issued at a discount and redeemed at face value at maturity': This is correct and aligns with the definition of zero coupon bonds.
Review the remaining statements: 'They are always issued at their face value' is incorrect because zero coupon bonds are issued at a discount. 'They pay interest only at the time of issuance' is also incorrect because zero coupon bonds do not pay interest at issuance or periodically.
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