ETF Glossary

A

ACTIVE MANAGEMENT

The process of hand selecting securities with the purpose of trying to outperform a benchmark index. Active portfolio managers use economic data, investment research, market forecasts, and other indicators to help make investment decisions.

AFTER TAX RETURN

The return from an investment after all income taxes have been accounted for and deducted. The SEC has adopted a number of rule and form amendments requiring mutual funds to disclose standardized after-tax returns. The amendments require a mutual fund to disclose standardized after-tax returns for 1-, 5-, and 10-year periods in the risk/return summary of the prospectus

ALPHA

A statistical measure of performance adjusted for risk. Alpha reflects the amount by which a mutual fund or portfolio outperforms or underperforms based upon its level of risk. Positive alpha means a portfolio’s risk-adjusted performance was higher compared to its corresponding benchmark index. Negative alpha means a portfolio’s risk adjusted performance was lower compared to its index. The alpha for index ETFs should match the accepted beta of the benchmark.

AMERICAN DEPOSITORY RECEIPT (ADR)

Receipt for the shares of a foreign based company held in the vault of a U.S. bank. Shareholders of ADRs are entitled to receive all dividends and capital gains. Individuals that want to own a foreign company without buying it on an overseas market can purchase an ADR listed on U.S. exchanges.

A-SHARES

A-shares can only be bought or sold by Chinese citizens or qualified foreign institutional investors approved by the Chinese government. A-shares are listed on either the Shanghai or Shenzhen stock exchange and some publicly traded Chinese companies may have simultaneous listings on the Hong Kong exchange. Generally, A-shares trade at a premium to H-shares because of ownership restrictions imposed by the Chinese government. (See H-SHARES) Despite these differences, the demand for H-shares has increased, especially since 2007, when investing in the Hong Kong market was opened to China’s mainland residents.

ASSET ALLOCATION

The process of apportioning investments among various asset classes, such as stocks, bonds, commodities, real estate, collectibles and cash equivalents. Asset allocation affects both the risk and return of investors, and is often used as a core strategy in basic financial planning.

ASSET CLASS

Refers to the categorization of an asset. Representative asset classes include equities, bonds, commodities, etc.

AUTHORIZED PARTICIPANTS

This term refers to large financial institutions, such as specialist firms and market makers, which are involved in the creation and redemption activity of ETF shares.

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B

BASIS POINT

Measurement used to quote bonds. One basis point is equal to 0.01%, or one one-hundredth of one percent. 100 basis points is equal to 1%, whereas 50 basis points would equal one half percent, or 0.50%.

BASKET

A unit or group of securities. The grouping of securities within an ETF is sometimes referred to as a basket.

BENCHMARK

A benchmark is a yardstick or standard for measuring the performance of an investment. For example, the Barclays Capital U.S. Aggregate Bond index is a popular benchmark for judging the performance of diversified taxable bond mutual funds. The goal of most money managers and investors is to outperform their respective benchmark.

BETA

Beta is a volatility measurement of a stock mutual fund or ETF versus a comparable benchmark like the S&P 500 stock index. A stock fund or ETF with a higher beta than the S&P 500 will rise or fall to a greater degree. In contrast, a stock fund or ETF with a low beta will rise or fall less.

BOND

A debt instrument issued by corporations and governments to raise capital. Interest on the outstanding debt is paid to bondholders at specific intervals, with the principal amount of the loan paid on the bond maturity date.

BLUE CHIPS

Blue Chip stocks are regarded as leading companies with world class products and services, universally recognizable brands and run by top-notch management teams.

BREAKPOINTS

Mutual funds with front-end loads, or a sales charge, enable investors to reduce front-end sales charges as the amount of that investment increases to certain levels called “breakpoints”. Each prospectus will have details on the breakpoints used to reduce the front-end sales charge.

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C

CALL OPTION

A call option gives its owner the right (not obligation) to buy a predetermined quantity of stock or commodities from the seller at a specified price (strike price) within a certain time frame (expiration date).

CHICAGO BOARD OPTIONS EXCHANGE (CBOE)

Founded in 1973 the CBOE changed options trading by creating standardized listed stock options. Prior to this time, trading options was largely unregulated. The CBOE lists options on interest rates, individual stocks, and various market indexes. The exchange is located in downtown Chicago, IL.

CLOSED-END FUND

Closed-end funds issue a fixed number of shares through an initial public offering and often use leverage to magnify their performance. Closed-end funds are bought and sold just like stocks and their share price often trades at a noticeable discount or premium to the fund’s net asset value.

CLOSET INDEX FUND

An actively managed fund that closely mimics the volatility and performance of an index fund.

COMMISSION

Transaction fee paid to a broker for executing a securities trade. Commission amounts vary and are often dependent on the size of trade, the frequency of trades, and sometimes the size of the brokerage account. Discount brokers tend to charge lower commissions for trades versus full service brokers.

COMMODITY INDEXES

Indexes that measure either the price or performance of physical commodities or the price of commodities as represented by the price of futures contracts listed on commodity exchanges.

CONTRARIAN

Describes an investor that believes and does the exact opposite of what the majority of investors are doing at any given moment. For example, contrarians might perceive value in a stock or industry sector that is out of favor or has performed poorly. While many investors are inclined to avoid unpopular investments, contrarians are likely to invest in these areas with the expectation of an eventual rebound or change in market sentiment.

COUNTERPARTY RISK

Counterparty risk is the risk that an institution defaults and fails to pay on a credit derivative, a credit default swap, insurance contract, a trade or a another financial transaction. ETFs that use swaps or derivatives may be exposed to counterparty risk. ETNs too are subject to counterparty risk because they rely on the creditworthiness of the issuing financial institution.

CREATION UNIT

The smallest block of shares in an exchange-traded fund that can be purchased or redeemed directly from the fund company at net asset value. Creation units are usually transacted in 50,000 share increments, making them large dollar transactions limited to large institutions and other authorized participants. Instead of receiving cash, the seller of a creation unit would receive a basket of securities that corresponds to the portfolio holdings in a particular ETF. This “in-kind” transfer process is unique to ETF’s and does not create tax consequences for the seller.

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D

DEFERRED SALES CHARGE

A sales charge deducted from an investment for exiting early, or before the sales charge ceases to exist. Mutual fund class B and C shares often carry a deferred sales charge. Also called back end load, CDSC or contingent deferred sales charge.

DISCOUNT TO NAV

A mutual fund, closed end fund or ETF whose share price is lower than fund’s net asset value (NAV). The occurrence of significant premiums or discounts with ETFs is rare, whereas with closed end funds it’s common.

DIVIDEND

Distribution of earnings paid out to shareholders. With mutual funds and ETFs, dividends can be a result of capital gains, interest income, or dividends paid to the fund itself by securities within the portfolio. Dividends are often paid quarterly, but the frequency can be less and is determined by fund management.

DIVIDEND YIELD

The distribution rate of a fund calculated by dividing the amount of the dividends per share by the per share market price of the fund. For example, a fund price of $20 that pays a $2 dividend per year has a 10% dividend yield.

DOW JONES INDUSTRIAL AVERAGE (DJIA)

The DJIA is a widely followed index that is used as a barometer of stock market performance. This stock index is based upon 30 major companies, or components in diversified industries, such as banking, consumer staples, retail, healthcare, and technology.

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E

EAFE INDEX

European, Australia, and Far East index computed and published by MSCI.

EFFICIENT MARKET THEORY (EMT)

The Efficient Market Theory (EMT) dissuades investors from using fundamental research to find undervalued or mis-priced securities. The central idea is that market prices already reflect the full knowledge of investors, which makes it impossible to outperform the market.

EMERGING MARKET

Refers to the economy or capital markets of developing nations, which are often new, un-established or have a limited history.

ENHANCED INDEXING

This market strategy seeks incremental outperformance of a benchmark index without changing the profile characteristics of the index. By using leverage, options trading, or another mechanism, enhanced indexing offers the potential of outperforming a benchmark index.

EXCHANGE-TRADED FUND (ETF)

ETFs or exchange-traded funds are low cost index funds that trade like stocks. ETFs offer intraday liquidity meaning they can be bought or sold when the stock market is open for trading. Generally, ETFs are very tax-efficient and have lower annual expenses compared to closed end funds and mutual funds. ETFs cover a broad spectrum of assets including stocks, bonds, currencies, real estate and commodities. ETFs can be sold short, leveraged with margin, hedged with call/put options or bought and held.

EXCHANGE-TRADED NOTE (ETN)

ETNs or exchange-traded notes are unsecured debt securities that pay a return linked to the performance of a single security or index. ETNs don’t usually pay a dividend or annual coupon and they have maturity dates that can range up to 30 years. ETNs held to maturity pay the return of the note’s underlying index minus its annual expense ratio. ETNs are subject to counterparty risk, meaning, the creditworthiness of the financial issuer can impact the note’s final return and value.

EXPENSE RATIO

The expense ratio of a mutual fund or ETF covers the cost of investment management, legal and administrative expenses, 12b-1 marketing fees and other associated expenses. The expense ratio does not include the cost of acquiring a fund, such as commissions or sales loads, and it’s expressed as a percentage of the fund’s average daily net assets.

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F

FINRA

The Financial Industry Regulatory Authority (FINRA) is a self-regulatory organization that oversees the market regulation of all securities firms doing business in the United States. FINRA was created in 2007 through the consolidation of the National Association of Securities Dealers (NASD) with the member regulation, enforcement and arbitration divisions of the New York Stock Exchange.

FUND OF FUNDS

Investment strategy that seeks to diversify risk exposure and manager style among various fund managers. Potential pitfalls include a lack of transparency and an added layer of fees. This strategy is popular with hedge fund investors looking to diversify risk among various fund groups.

FUND FLOWS

Describes the money flow into or out of mutual funds and ETFs. The Investment Company Institute (ICI) tracks and reports monthly fund flow data.

FUNDAMENTAL INDEXING

Fundamental indexing uses a company’s fundamentals such as sales, profits, book value, revenues and dividends to determine its weighting within an index. Some fundamental indexes use a multi-factor approach whereas others use one key factor.

FUND OVERLAP

Fund overlap refers to the duplication in owning two or more ETFs or mutual funds that have the same identical securities and/or underlying investment strategy. Investors are effectively paying twice for double work. They pay one fund company to execute an investment strategy and then they pay again to a competing fund to do the exact same work.

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G

GLOBAL FUND

A type of mutual fund, closed end fund, or ETF designed to give exposure to international or emerging market securities, including the United States.

GOLD FUND

A type of mutual fund or ETF designed to give exposure to gold related securities or to physical gold itself. Gold securities can include stocks in companies engaged in the production, processing, or mining of gold. Funds that track the price of gold itself will generally acquire and store physical gold or gold derivatives. Gold funds are often used to hedge against inflation and currency risks.

GOVERNMENT SECURITIES

Securities issued by U.S. government agencies and international governments. U.S.Treasuries are generally considered the safest, because they are backed by the full faith and credit of the government.

GRANTOR TRUST

This type of fund structure distributes dividends directly to shareholders and allows investors to retain their voting rights on the underlying securities within the fund. The original fund components of the index remain fixed and this ETF structure is not registered under the SEC Investment Company Act of 1940. Merrill Lynch’s HOLDRs follow this format.

GROWTH AND INCOME FUND

A mutual fund, closed end fund, or ETF with both the growth of capital and income as the primary investment objective.

GROWTH FUND

A mutual fund, closed end fund, or ETF with the growth of capital as the primary investment objective.

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H

HEDGE

A strategy used to reduce financial risk or the possibility of loss. For example, an investor owning 100 shares of an S&P 500 stock fund could hedge that long position by owning a short position or put options on the S&P 500 index.

H-SHARES

H-shares are offered by companies incorporated in China and are listed on the Hong Kong Stock Exchange or another foreign exchange. They are governed by Chinese law and their shares trade in Hong Kong dollars. Generally, H-shares trade at a discount to A-shares because of ownership restrictions imposed by the Chinese government. (See A-SHARES) Foreigners are prevented from investing in A-shares whereas only citizens of China can buy them. Despite these differences, the demand for H-shares has increased, especially since 2007, when investing in the Hong Kong market was opened to China’s mainland residents.

INCOME FUND

A mutual fund, closed end fund, or ETF that has generating income, as the primary investment objective. Income can be derived from various sources, including interest payments, dividends, and capital gains.

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I

INDEX

A statistical measure used to track the aggregate performance of stock, bond and commodities markets. Widely followed indexes include those developed and managed by Standard & Poor’s, Russell, MSCI and Dow Jones.

INDEX FUND

A type of mutual fund or ETF that attempts to match the performance of a stock, bond or commodity index. Index funds are sometimes referred to as passive funds and are notorious for their tax efficiency and low fees. Some index funds follow traditional market cap indexes whereas others follow an equal weight or fundamental indexing approach.

INDEXING

Investment strategy that seeks to match the exact performance of a specific market or benchmark index.

INDEX OPTIONS

Calls and puts on stock or bond indexes. Index options allow investors to trade a particular market sector or index of securities, without having to make individual purchases of each security in that sector. Index options are listed on various exchanges, including the American, New York, and Chicago Board Options Exchange.

INVERSE ETFs

(See Short ETFs)

INVESTMENT COMPANY INSTITUTE (ICI)

The Investment Company Institute (ICI) is the national association of the U.S. investment company industry. Founded in 1940, its membership includes sponsors of mutual funds, ETFs, closed end funds and unit investment trusts.

INVESTMENT COMPANY ACT OF 1940

The Investment Company Act of 1940 regulates the organization of companies, including mutual funds that engage primarily in investing and trading in securities. The Act requires these companies to disclose their financial condition and investment policies to investors on a regular and timely basis.

INVESTMENT GRADE

Bonds whose issuers are rated AAA to BBB for safety and ability to repay principal by Standard & Poor’s or Moody’s Investors Service.

INVESTMENT STYLE

Indicates the approach of an investment manager in selecting securities. For example, a certain manager may be value oriented by emphasizing companies with low P/E or book-to-value ratios, whereas another may emphasize earnings and profit growth.

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L

LARGE CAP

A large company or large cap stock generally refers to companies with a market capitalization or size over $5 billion.

LEVERAGE

Margin and use of option contracts are forms of leverage which allow investors to enhance their returns without adding to their investments.

LEVERAGED ETFs

The main objective of leveraged ETFs is to deliver magnified performance of a particular stock, bond or commodity index. Most leveraged ETFs attempt to duplicate daily index returns by two or three times. Short leveraged ETFs aim for daily index returns that move in the opposite direction, but with magnified performance of two or three times.

LIQUIDITY

Liquidity refers to the ability to convert an asset to cash without substantially affecting its price. Assets that are quickly converted to cash have good liquidity whereas those that take time are less liquid. The liquidity of an ETF is best determined by the liquidity of the securities in its underlying stock, bond or commodity index along with the trading volume of the ETF itself. General market conditions are another secondary factor which can influence an ETF’s liquidity.

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M

MARKET CAPITALIZATION

The market capitalization of a corporation is the measurement of the company’s value based upon the company’s number of outstanding shares multiplied by its current share price.

MID CAP

A mid-sized company or mid cap stock generally refers to companies with a market capitalization or size between $1 billion and $5 billion.

MSCI

MSCI distributes index and company-level data and also licenses the MSCI indexes to third parties for the purposes of creating mutual funds, ETFs, OTC derivatives and other financial products.

MUNICIPAL BOND

Municipal bonds or “munis” are debt issued by city, state and local governments to finance various projects. Bond proceeds are typically used by local governments to construct or maintain highways, hospitals and schools. The interest income paid by municipal bonds is free from federal income tax and in many cases, exempt from state and local taxes as well.

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N

NASDAQ

National Association of Securities Dealers Automated Quotations is a computerized system that quotes securities traded over the counter and on other exchanges.

NET ASSET VALUE (NAV)

Represents the per share price of a mutual fund. With closed end funds and ETFs, the true NAV is not always reflected in the share price of the security because it may trade at a premium or discount to the NAV. The calculation of NAV is the fund’s total net assets divided by the number of shares outstanding, minus fees and expenses.

NEW YORK STOCK EXCHANGE

Located on Wall Street in New York, this is the oldest and largest stock exchange in the U.S. Also known as the “Big Board”, or “Exchange”.

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O

OPEN END FUND

See Mutual Fund

OPEN END INDEX FUND

This type of fund structure reinvests dividends the date of receipt and pays them out via a quarterly cash distribution. This ETF structure is also permitted to use derivatives, loan securities and it’s registered under the SEC Investment Company Act of 1940. ETFs that utilize this legal structure include iShares and the Select Sector SPDRs.

OVER THE COUNTER (OTC)

Over the counter trading is conducted by market makers in OTCBB and Pink Sheets securities using inter-dealer quote services like the Pink Quote and the OTC Bulletin Board (OTCBB). OTC stocks are not usually listed or traded on a stock exchange, although exchange listed stocks can be traded in the OTC market.

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P

PASSIVE MANAGEMENT

A market strategy that involves selecting a benchmark index to assure investment performance is the same as the underlying index. Passive investing assures that an investor will not underperform (or outperform) a market index. Passive management is opposite of active management.

PERFORMANCE DRAG

A reduction of portfolio performance due to various factors. An example of performance drag occurs when gains within a portfolio are offset by various expenses, such as management fees, transaction costs and taxes. These expenses create a drag or negative effect on the portfolio’s performance.

PORTFOLIO TURNOVER

Portfolio turnover measures the frequency by which securities within a mutual fund or ETF are bought and sold. Turnover is determined by the dollar value of buys or sells (whichever is less) during a year divided by the total assets in the fund. For example, a mutual fund with $200 million in assets that has $100 million of sales and $100 million worth of purchases (using the same proceeds) during the year would have a 50% turnover rate, indicating an average holding period of two-years. A churn rate of 100% signifies that a fund manager has sold the fund’s entire portfolio and bought new holdings during the course of a year. High portfolio turnover translates into higher investment costs whereas low portfolio turnover is better because it lessens the impact of trading and tax related expenses.

PREMIUM TO NAV

A mutual fund, closed end fund or ETF whose share price is higher than fund’s net asset value (NAV). The occurrence of significant premiums or discounts with ETFs is rare, whereas with closed end funds it’s common.

PROSPECTUS

Required by securities laws and issued by mutual fund companies and ETFs, the prospectus is a legal document that discloses the investment objectives of the fund, operating history, fund management, management fees, portfolio holdings, and other related financial data. Brokers are required to give a prospectus to investors before they invest.

PUT OPTION

A put option gives its owner the right (not obligation) to sell a predetermined quantity of stock or commodities at a specified price (strike price) within a certain time frame (expiration date).

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R

REAL ESTATE INVESTMENT TRUST (REITs)

Real Estate Investment Trusts or REITs are publicly traded companies involved in property development, management or sales. REITs cover various segments of the real estate market including apartments, hotels, industrial properties, medical facilities, shopping malls and offices.

RED CHIPS

Red Chips are Chinese stocks listed on the Hong Kong Stock Exchange but incorporated internationally. Foreigners are allowed to invest in Red Chips. Some Red Chips also issue A-shares, but only Chinese citizens can invest in them.

RUSSELL INDEXES

In 1984, Frank Russell Company created the Russell family of stock indexes as part of a more accurate and comprehensive system for evaluating the performance of investment managers. Russell now maintains 21 U.S. stock indexes and has launched similar broad-market and style indexes in Japan.

R-SQUARED (R2)

R-squared measures the correlation of a fund’s movement in comparison to its corresponding benchmark. An R squared score of 1.00 would indicate a perfect correlation, whereas a score of 0.00 indicates no correlation.

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S

SECTOR ROTATION

An investment strategy that uses elements of market timing to identify industry sectors of the economy ready to outperform. Conversely, a sector rotation strategy would likely avoid or underweight industry sectors that are expected to lag the rest of the market.

SECURITIES AND EXCHANGE COMMISSION (SEC)

Federal agency created by the Securities Exchange Act of 1934 with the primary mission of protecting investors and maintaining the integrity of the securities markets. The SEC has five Commissioners who are appointed by the President of the United States with the advice and consent of the Senate. Their terms last five years and are staggered so that one Commissioner’s term ends on June 5 of each year.

SEC YIELD

A yield calculation developed by the SEC to standardize yield data for mutual funds, close-end funds, and ETFs. The calculation uses the fund’s net investment income over the last 30 days, minus income generated from capital gains or other sources. SEC yields are often quoted for bond funds.

SHARE CLASSES

Some mutual funds use multiple share classes for the same underlying portfolio. For example, investors that buy A shares pay an upfront sales charge to enter a fund, whereas a class B share would defer the sales charge. Some mutual fund families like Vanguard offer their ETFs as an additional share class of existing index mutual funds.

SHARPE RATIO

A measure of a fund’s historical returns adjusted for risk or volatility. The calculation is fund return minus the return on 3-month treasury bills divided by the fund standard deviation.

SHORT ETFs

The main objective of short ETFs is to deliver inverse or opposite performance to a particular stock, bond or commodity index. Most short ETFs attempt to duplicate daily index returns in the opposite direction. Some short ETFs aim for daily index returns in the opposite direction but with leverage or magnified performance.

SMALL CAP

A small company or small cap stock generally refers to companies with a market capitalization between $1 billion and $250 million.

STYLE BOX

The investment style box is a visual tool that classifies mutual funds and ETFs by the size (large, mid or small) of stocks a fund holds along with the investment style of stocks (value, growth or blend) it holds. The style box has nine investment categories or styles and was developed by Morningstar.

STYLE DRIFT

Style drift happens when a fund diverts from its prospectus defined investment strategy to pursue another course.

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T

TARGET DATE FUND

A type of mutual fund or ETF that automatically adjusts its mix of stocks, bonds and other assets based upon a specified year or target date. Typically, a target date fund will reduce its exposure to stocks as it approaches its planned target date and maintain a fixed allocation for the remainder of time.

TAX LOSS HARVESTING

This market strategy focuses on selling a portfolio’s worst performing security to 1) offset realized capital gains of winning securities, and 2) to reinvest the sale proceeds into securities with a similar investment objective or correlation.

TRANSPARENCY

Refers to the visibility level of securities holdings within a given portfolio or fund. Generally, the transparency of an index fund will be greater than an actively managed fund. This is due to the fact that holdings within an index fund are openly disclosed and available.

TECHNICHAL ANALYSIS

An attempt to predict the performance of a security by spotting trends in price, without regard to the underlying fundamentals, such as cash flow and balance sheet. Sometimes referred to as “charting”.

TICKER SYMBOL

The lettering system used to identify a stock, mutual fund, or ETF on an exchange. Also called trading symbols.

TREASURY INFLATION PROTECTED SECURITIES (TIPS)

TIPS are U.S. government debt indexed to inflation. The principal of a TIPS either increases with inflation or decreases with deflation, as measured by the Consumer Price Index. At maturity you are paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

TURNOVER

(See Portfolio Turnover)

12b-1 FEE

12b-1 fees, also known as distribution or marketing fees, are one component of a mutual fund’s annual operating expenses and can be thought of as an alternate way of paying sales-related expenses, such as compensating investment professionals. A fund can have 12b-1 fees only if its board of directors has approved a 12b-1 plan authorizing their payment.

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R

UNIT INVESTMENT TRUST

This type of fund structure does not reinvest dividends in the fund and pays them out via a quarterly cash distribution. In order to comply with diversification rules, this ETF structure will sometimes deviate from the exact composition of a benchmark index. This type of fund is registered under the SEC Investment Company Act of 1940. The Dow DIAMONDS (DIA), PowerShares QQQ (QQQQ) and the S&P 500 SPDRs (SPY) follow this product format.

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V

VOLATILITY

Volatility is determined by the price movement (rise or fall) of a security. Securities that experience sharp increases or declines within a short time frame are considered more volatile than those that don’t. (See Beta)

VOLUME

Total number of shares or contracts traded on a security. Volume data is tracked and reported daily by major stock exchanges around the world.

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W

WINDOW DRESSING

Denotes the selling of underperforming securities by money managers just before the end of each quarter, so these holdings don’t appear in shareholder reports as significant investment positions. This selling activity is often accompanied with buying activity of strong performing securities. After quarterly reports are issued, the portfolio will reveal positions in strong performing securities, despite the fact that the majority of the capital gains in these were never experienced by shareholders. Window dressing is a cosmetic affect and adds little or no value.

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Y

YEAR-TO-DATE (YTD)

The period beginning at the start of the calendar year up until the most current date.

YIELD CURVE

A graph that illustrates the relationship between the yields of bonds with the same credit quality, but with varying maturities. A positive yield curve means short term interest rates are lower versus long term rates. A negative yield curve is just the opposite, whereas a flat yield curve shows little variance in the yields of short term bonds and long term bonds.

YIELD SPREAD

The difference in yield between bonds.

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Z

ZERO COUPON BOND

A zero coupon bond is bought at a discounted price to its face value and the principal is repaid at the bond’s maturity date. Unlike conventional bonds which make semi-annual payments, zero coupon bonds do not make periodic interest payments. U.S. Treasury bills, U.S. savings bonds and any other bond that’s been stripped of its coupons are all examples of zero coupon bonds. Investors earn a return from zero coupon bonds after compounding interest is paid at maturity plus the difference between the discounted price of the zero bond and its par or redemption value.

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