A zero coupon bond is defined as “a debtsecurity that does not pay back an interest (a coupon)”. But it is traded in astock exchange at a greater discount, generating profits at the maturity whenthe bond is redeemed for its full face value. Others are bonds that arestripped off their coupons by a financial institution and resold as a zerocoupon bond. The entire payment including the coupon at the time of maturity isoffered later. The price of zero coupon bonds have a tendency to fluctuate morethan the prices of coupon bonds (Momoh, 2018).Yield curve is obtained by plotting theinterest rates obtained from the securities against the time (monthly, daily orannually) for securities having different maturity dates. These plotted datahave been used in various studies to identify behavior of the securities and topredict the future behaviors.
Various studies have been conducted toinvestigate the behavior of various types of treasury bonds and bills by usingthe yield curve.The return on capitalinvested in fixed income earning securities is commonly called as yield. Theyield on any instrument has two distinct aspects, a regular income in the formof interest income (coupon payments) and changes in the market value and thefixed income gearing securities (Thomas et al.).
Durbha, Datta Roy andPawaskar in their paper titled “Estimating the Zero Coupon Yield Curve” havepointed out factors the Maturity period, Coupon rate, Tax rate, Marketabilityand Risk factor, which make a yield differential among the fixed income bearingsecurities. Further they have pointed out that the government securities whichare considered as the safest securities to invest also carries hidden risks as Purchasingpower risk and Interest rate risks.According to the authors thebehavior of inflation within the country arises due to the purchasing powerrisk and lead to changes in real rate of return. Interest rate risk is produceddue to the oscillations in prices of the securities. In such a case theinvestors should regulate their portfolios accordingly.Numerous contributions in finance have proved thatimposing no-arbitrage constraints in empirical models of the yield curveimprove their empirical features.