Can someone explain to me how this works? I’ve seen a few sites trying to sell information on this. I’m sure I can get this info for free. Just curious what it is and how it works. Thx.
Zero coupon bonds are long term bonds bought at a discount that mature in a set amount of time. You buy them at a percentage of their face value and use them as additional collateral or additonal “sweetner” in a deal. For instance (this is an example only and I don’t have access to ZCB prices!), you buy some 20 year Zero Coupons with a face value of $30K but you pay $8-10K for them. As additional collateral for a loan you give the ZCB to the seller that is doing a seller-finance for you.
The Sheets Course actually has some pretty creative uses for bonds…
Keith
But is it realistic that a seller would accept a zcb as payment? The value of a zcb is not gauranteed, correct?
Also, where would I get info on pricing/purchasing these? Is it available via ETrade?
ZCB are usually municipal bonds…there are NO guarantees in the financial world but they are generally pretty stable.
Who knows what a seller would do? He absolutely won’t if you don’t ask!
Keith
The majority of Zero Coupon Bonds are based on Government Bonds.
But, there are also Corporate Zeros that are higher risk and therfore are based on a higher interest rate (exactly as normal “interest paying” corporates vs Government bonds).
Zeros have to be bought through a licensed securities dealer just as trading other stocks or Bonds.
It is not very likely you will find many sellers willing to accept zeros (if they understand what you are actually offering).
The problem with using zeros for this purpose is that it is easy to take advantage of unsophisticated homeowners and that unfortunately is how the majority of these deals are accomplished today.
For example if you told someone you were giving them a $100,000 Zero coupon bond as collateral in a deal but your cost for the bond was only $50,000, It would be unethical (and perhaps even illegal according to how it was presented) unless the seller fully understands that the $100K ZCB is not worth $100K but only $50.
It will eventually be worth $100K but that might be many years away.
How Long? Use the “rule of 72” to get an idea. Divide 72 by what interest rate you choose and the resulting number is how long it takes to double a number.
For example: using an interest rate of 6%, Divide 72 by 6 to get 12 years for a Zero to double from a$50,000 to $100,000.
On the other hand using 12%, 72/12 = 6 years.
This is why using this technique can be more likely to be accepted at a time of high interest rates (because it would take a much shorter time for the bonds to reach maturity), than currently at a time of low rates.
Zeros can also be useful in some sophisticated Real Estate Transactions, but that is really not applicable to this discussion…