A Z bond (also known as an accrual bond) is a type of bond that accrues interest added to the principal balance of the Z bond, which becomes payable after satisfaction of all prior bond classes.
It is often the last bond to mature. It pays no interest while principal is paid on earlier bonds. However, interest that would have been used to pay the Z bond is used to pay down principal on earlier bonds.
As it accrues interest as opposed to paying it out, a Z bond is comparable to a zero-coupon bond.
Z bonds are frequently used in collateralized mortgage obligations (CMO).
According to the Nasdaq Business Glossary, a Z Bond is:
“A bond on which interest accrues but is not currently paid to the investor but rather is added to the principal balance of the Z bond and becoming payable upon satisfaction of all prior bond classes.”