How are investors in zero-coupon bonds compensated for making such an investment?

• A. They receive a fixed coupon payment every six months.
• B. They receive the bond's face value at maturity, which exceeds the purchase price, resulting in a gain.
• C. They receive interest payments periodically throughout the life of the bond.
• D. They are paid dividends annually based on the issuer's profits.

Answer: (B)

Verified step by step guidance

1. Understand the concept of a zero-coupon bond: A zero-coupon bond is a type of bond that does not pay periodic interest (coupons). Instead, it is sold at a discount to its face value and compensates investors by providing the full face value at maturity.
2. Identify how investors are compensated: Since zero-coupon bonds do not pay periodic interest, the compensation comes from the difference between the purchase price (discounted price) and the face value received at maturity.
3. Analyze the mechanics of the investment: Investors purchase the bond at a price lower than its face value. Over time, the bond accrues value, and at maturity, the investor receives the full face value, which includes the gain from the initial discount.
4. Compare with other types of bonds: Unlike bonds that pay periodic interest (coupon payments), zero-coupon bonds provide a lump-sum payment at maturity. This structure is particularly attractive for investors seeking long-term growth rather than regular income.
5. Conclude the explanation: The gain realized by investors in zero-coupon bonds is the difference between the discounted purchase price and the face value received at maturity. This gain compensates them for the time value of money and the risk associated with the investment.