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Subject:  Re: zero coupons Date:  8/14/2001  11:05 PM
Author:  foobar73 Number:  1942 of 36394

I purchased some zero coupon bonds for my daughter some years ago. It seems the price doesn't move linearly, (there was a major hiccup in the price in April) and since I'm a new Fool with nary a financial brain in my head I am not sure why. However the price has now recovered and I'm wondering if I should sell before maturity and get into something else? Is it true that the yield varies with interest rates and if so would one expect a spike in the price if the Feds lower rates? I can't find anything online about these things. They mature in Aug 04 and Nov 05.

Zeros are particularly sensitive to interest rate movements. If interest rates go up, nobody would want to buy an "old" bond with lower rates; subsequently, the price must move down to make the old bond more attractive. Likewise, should interest rates go down, prices on existing bonds move upwards.

However: at maturity, you *will* receive the face value of the bonds, regardless of the prevailing interest rates. There is no risk of loss when you hold bonds to maturity, assuming the issuer does not default. So, if your original intention was to hold the bonds to maturity, you shouldn't face any unanticipated consequences if you do so.

If you do decide to trade the bonds, note that you will likely lose a percent or two, due to the "dealer spread". That is, bond dealers tend to mark up the price of bonds when they sell them to you, and mark down the price when they buy them back from you. Since your bonds seem to mature fairly soon, your potential gains on sale might not be large enough to overcome the loss due to the spread.
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