It is a measure of the theoretical value of a zero-coupon bond at any given point in time. Because there are no interest payments unlike with traditional bonds, the interest of a zero-coupon bond accrues until maturity. Therefore, the CAV can be calculated by adding all of the interest earned up to a given point in time to the original price.
Calculating a zero-coupon bond’s CAV becomes important if the bond carries a call provision. This is because call provisions for zero-coupon bonds are typically linked to the bond’s CAV. The provision will usually stipulate that the issuer can call the bond on a specific date at a price that is a premium to the bond’s CAV.
A zero-coupon bond is trading at a premium if it costs more than its CAV at that specific point in time. Conversely, the zero-coupon bond is trading at a discount if it costs less than its CAV.