What is a Zero Coupon Municipal Bond?

Municipal bonds, or “munis,” are a debt instrument issued by government entities, such as cities, counties and states.  Generally munis are used to generate capital for public improvements, such as sewers and roads.  Munis are similar to a corporate bond in that they are rated by credit agencies such as Moody’s and S & P.

Most municipal bonds have a coupon rate, which pays a regular dividend during the term of the bond until maturity.  However, zero coupon municipal bonds were introduced in the early 1980s for investors who were not interested in a regular income stream, but rather wanted the benefit of purchasing a short-term, low risk bond with a single interest payment at maturity.  Zero coupon municipal bonds offer no interim “coupons,” or dividend payments.

Benefits of a Zero Coupon Municipal Bond

There are many benefits for investors who allocate part of their wealth into zero coupon municipal bonds.

• Tax Free – The government wants to encourage investment in public works.  Thus, most zero coupon municipal bonds are tax exempt, making them an attractive alternative to corporate bonds.  Generally, an investor within a higher tax bracket will benefit the most from a tax free zero coupon municipal bond.

• Better Credit Rating – Zero coupon municipal bonds are rated by at least one of the major rating agencies.  A majority of all zero coupon municipal bonds generally are good quality and are rated A or better.  In fact, many zero coupon municipal bonds carry insurance guaranteeing from default.  These bonds usually are rated AAA or better.

• Low Minimum Investment – Since zero coupon municipal bonds offer only a single interest payment at the maturity date, they are usually heavily discounted from the face value.  For instance, a 20-year, $20,000 zero coupon municipal bond may sell for about $6,700.  At maturity in 20 years the bond will pay $20,000, usually tax free.

• Liquidity – Zero coupon municipal bonds have many ranges of terms.  There are many short-term zero coupon municipal bonds in the 3 to 5 year maturity range.  This offers investors great liquidity in being able to sell the bond if they are in need of cash during the term.

Where Can You Buy a Zero Coupon Municipal Bond?

Investors can purchase zero coupon municipal bonds directly from the issuing government when the bonds are first issued.  There are many websites that offer information about new zero coupon municipal bond issues, such as the US Department of the Treasury.

However many investors do not wish to perform the research for newly listed zero coupon municipal bonds and would rather purchase through an investment brokerage house.  Most major brokerage firms deal with secondary sales of zero coupon municipal bonds.  Check with your investment broker if you are interested in putting part of your wealth in zero coupon municipal bonds.