A zero-coupon bond does not pay interest during its life. Instead, you buy the bond at a deep discount from its face value. When the bond matures, you receive the face value, which represents the principal plus accrued interest.

Even though you won't receive annual interest payments, you might have to pay income tax on the imputed or "phantom" interest that accrues each year. To avoid this problem, buy zero-coupon bonds in an IRA or other tax-deferred account or buy tax-free municipal zero-coupon bonds.

See http://www.sec.gov/answers/zero.htm

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