Definition of Z-Bond

What is a Z-Bond

A Z-bond is a type of bond that will accrue interest to be added to the principal balance, which becomes payable after satisfaction of all other bond classes. It is created by separating the interest and principal payments of a mortgage-backed security (MBS) into two different securities. The Z-bond, also known as an accretion bond, accrual bond or accrual tranche, is the security that does not receive any periodic interest payments. Instead, the interest payments are accumulated or accrued and added to the principal of the bond, which is paid out at a maturity date.

Higher Risk for Higher Reward

Z-bonds are typically created to provide a way for investors to take on a higher level of risk in exchange for a potentially higher return. Since the interest payments are deferred until maturity, Z-bonds tend to have a higher yield than other tranches of the same mortgage-backed security. However, because the interest is not paid out periodically, Z-bonds are generally considered to be more speculative and riskier than other tranches.

Z-bonds are often used as a way for investors to take on the risk associated with the prepayment of mortgages, which can impact the cash flows of mortgage-backed securities. Since Z-bonds are not subject to prepayment risk, they can provide a more stable return for investors.

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Related Investment Terms

Bond

Global Bond

Treasury Bond