Zero-coupon CD

Investing in the stock market can be a bit tricky, particularly if you are new to the process. You should understand that there are many different ways in which you can invest your money and hope for a nice return on your investment. A zero-coupon CD is much like a zero-coupon bond. They allow you to purchase CDs or Certificates of Deposit at a discounted rate to the par value of that CD. You normally receive a much higher interest rate with zero-coupon CDs than with traditional CDs however, you do not receive interest each month. Instead of monthly dividends you simply receive the entire amount of your profit at the end of the CD term.

For instance, if you were to purchase a twelve year CD at $100,000 and that CD had an interest rate of 7 percent and you paid $50,000 for that CD then you would not receive any interest payments at all during the 10 year term. Instead, when the CD matures you would receive the interest amount along with the face value amount. The interest payments are invested during the term of the CD. You should note however that even though you do not receive any actual interest payments throughout the year, you are still required to pay tax on the interest. You will need to pay taxes on the interest payments during the year even though you have not actually received that money. In the above scenario, you would be responsible for paying tax on $3,500 and each year you will pay a larger tax amount on your interest payments. You need to consider this to ensure that you have the funds available to pay tax on the interest on your CD while you are actually waiting to be paid that interest. Under current United States tax laws you must pay taxes on any interest that is accrued while it is accrued as opposed to when you actually receive the interest payments. You will need to have the funds available to pay taxes on the interest during the first year even if your CD does not mature for several years down the road.

Calculating the actual interest that has accrued on a zero-coupon CD is not difficult if you know the proper formula to use. Using the formula where P is principal, T is the number of days until term and R is the annual interest rate, you can calculate your interest as follows:

Accrued interest will equal P X R / 365 T. For instance, if you invest in a CD of $10,000 that has an annual interest rate of 6 percent, you will have accumulated $164.38 in interest after just 100 days. Many investors prefer the more traditional approach to CDs simply because they pay out a steady stream of revenue throughout the term of the CD as opposed to waiting until the CD matures to receive a lump sum payment. If you are relying on the interest payments from your CD for money throughout the year then a zero-coupon CD is simply not the best choice. However, if you want to purchase a CD at a lower rate with a higher interest rate than traditional certificates of deposit and you do not mind waiting until the CD matures to receive your interest then a zero-coupon CD is a good choice. You may receive a much higher overall interest rate. Just remember that you must prepare yourself to pay the taxes on the CD throughout the first year rather than when the interest is actually paid to you. You can find more information on these and other types of CDs as well as brokers and financial institutions that offer them online.

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