Where to hold zero-coupon bonds is a taxing problem. (Pun intended.) If they are held in a cash or margin account, the implied interest received each year is considered a taxable event. If that zero-coupon bond defaults, then taxes were paid on ghost returns, which exacerbates one’s losses, adding insult to injury.
The possible workaround I stumbled onto years ago was to park my spec-grade zeros in my IRA. If the position failed, which was clearly a possibility, all I would lose was my initial purchase-price.
Here’s an example of what amounts to a lottery ticket I bought years ago that’s nonetheless still doing well enough. A Michigan Tobacco Settlement bond, the zeros of '52, came to market Aug '07 at 4.120, offering a YTM of 7.25. A couple years later, the price had dropped to 2 and change. I thought the bond, CUSIP 594751AH2, a offered a reasonable opportunity. I pitched them in this forum and bought 30. Scott agreed and bought some as well.
A couple of years later, probably in '17, we both were partially called at 8.269, which resulted in a decent enough YTM of 23.6% and a total gain for us of around 388%. Since I held the position in my IRA, a taxable event wasn’t triggered, only the taxes eventually due when I would having start doing mandatory distributions.
I still own five of those zeros, whose price has backed off from the call price, but still offers a YTM of 7.904 if bought now. So here come some caveats. This is a triple-CCC, spec-grade issue. Unless you’re running a spec-grade campaign in which this bond is only one of many positions, buying it now is not prudent thing to do, never mind that its due date is really far out there and that 8% is scant reward for the risks involved.
In short, it’s the sort of situation in which, if you already own it, there’s probably no reason to sell it. But if you don’t own it, there’s no need to go looking for trouble when comparable, but less risky yields can be obtained elsewhere in the bond market and multiple returns of that in the equity markets.