Zero coupon yield
The rate of return on an investment today, for a single cashflow at the final maturity of the instrument. No intermediate interest is payable or receivable. (There are no interest coupons, hence the name 'zero coupon'.)
The zero coupon yield is equal to the current market rate of return on investments in zero coupon bonds of the same maturity.
Example: Cash flows from 3-period zero coupon instrument
The zero coupon yield for the maturity 0-3 periods is 2% per period.
This means that a deposit of £1,000,000 at Time 0 periods on these terms would return:
£1,000,000 x 1.023
= £1,061,208 at Time 3 periods.
(No intermediate interest is payable.)
An application of zero coupon yields is the pricing of zero coupon bonds.
The zero coupon yield is also known as the Zero coupon rate, spot rate, or spot yield.
If we know the zero coupon yield, we can calculate both the forward yield and the par yield for the same maturities and risk class.
The conversion process and calculation stems from the 'no-arbitrage' relationship between the related yield curves.
This is illustrated on the page Converting from zero coupon rates.