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$503

$503.00

Notice that under the old rules, zero coupon bonds were more attractive because the deductions for interest expense were larger in the early years (compare the implicit interest expense with the straight-line expense).

Under current tax law, EIN could deduct $75 in interest paid the first year and the owner of the bond would pay taxes on $75 in taxable income (even though no interest was actually received). This second tax feature makes taxable zero coupon bonds less attractive to individuals. However, they are still a very attractive investment for tax-exempt investors with long-term dollar-denominated liabilities, such as pension funds, because the future dollar value is known with relative certainty.

Some bonds are zero coupon bonds for only part of their lives. For example, General Motors has a debenture outstanding that is a combination of a zero coupon and a coupon-bearing issue. These bonds were issued March 15, 1996, and pay no coupons until September 15, 2016. At that time, they begin paying coupons at a rate of 7.75 percent per year (payable semiannually), and they do so until they mature on March 15, 2036.

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