A zero-coupon bond will pay $1,000 at maturity in four years and currently trades for...

A zero-coupon bond provides no periodic interest payments. Its return arises from the difference between the discounted purchase price and the amount received at maturity.

The annual compound yield is calculated as:

Yield = (Face value ÷ Price)¹⁄ⁿ − 1

Substituting the figures:

Yield = ($1,000 ÷ $780)¹⁄⁴ − 1

Yield = approximately 0.0641, or 6.41%

Option C is correct.

The calculation determines the annual compounded return required for $780 to grow to $1,000 over four years. Dividing the $220 discount by four years would not produce the correct yield because that method ignores compounding and the changing investment base.

Zero-coupon bonds can provide a known maturity value when held to maturity, subject to issuer credit risk. However, they can be highly sensitive to interest-rate changes because all cash flow is received at maturity. They also generate no interim cash income, and their tax treatment in a non-registered account may not match the actual timing of cash receipts.

The CIRO Retail Securities syllabus requires candidates to calculate yields on zero-coupon instruments and analyze the relationship between term, yield, bond price and interest-rate sensitivity.

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