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

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

Answer: (A)

Verified step by step guidance

1. Understand the concept of zero-coupon bonds: These are bonds that do not pay periodic interest (coupons) during their life. Instead, they are issued at a discount to their face value and compensate investors by paying the full face value at maturity.
2. Identify how investors are compensated: Since zero-coupon bonds do not provide periodic interest payments, the compensation comes from the difference between the purchase price (discounted price) and the face value received at maturity.
3. Analyze the options provided: Evaluate each option to determine which aligns with the characteristics of zero-coupon bonds. For example, periodic interest payments or fixed coupon payments are not applicable to zero-coupon bonds.
4. Focus on the correct option: The correct answer is that investors receive the bond's face value at maturity, which is higher than the purchase price. This aligns with the fundamental structure of zero-coupon bonds.
5. Conclude the reasoning: Investors benefit from the appreciation of the bond's value over time, as the bond's price gradually increases to its face value by the maturity date. This is the primary way zero-coupon bonds compensate investors.