CFA, Finance, FRM

What Are STRIPS?

Introduction to STRIPS:

  • STRIPS (Separate Trading of Registered Interest and Principal of Securities) are debt securities that are created through the method of coupon stripping.
  • They are similar to the traditional Treasury bonds, the only difference being that the bond’s principal has been separated i.e. stripped off from its interest(coupon) making it two separate entities.
  • STRIPS are the form of zero-coupon securities, meaning that they make no periodic interest payments, as most bands do. Instead, we can buy them at a deep discount from their face value, which is the amount you receive when they mature.
  • Thus, investors know exactly how much they will earn from their STRIPS investments. This, plus the high security of the bonds that back them, make STRIPS popular with some investors.
  • Many brokerage firms created their own zero-coupon securities before 1986 by stripping the coupons from Treasury bills and bonds they purchased and held in escrow. Eg CATS, TIGRs, etc. Then the Treasury introduced the STRIPS system, in which brokerages create zero coupons based on book-entry receipts for Treasury instruments. STRIPS are sold by brokerage firms while they are based on underlying Treasury instruments.

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Types of STRIPS:

  • Investors may then choose to purchase securities based on either the Principal [PO Strip] or Interest [IO Strip] of the bond.

Why Are STRIPS Popular?

  • They are backed by US Treasury Securities, which makes them very high-quality debt instruments.
  • It allows investors to take advantage of the earnings of Treasury bills and bonds without a large outlay of capital. For an instance, a minimum investment of $10k is required to purchase Treasury bonds while a STRIP based on the interest of the T-bond may cost only a few hundred dollars.
  • STRIPS are zero-coupon bonds meaning that in advance you know what will be the future value of your investment.
  • A variety of maturity dates are available.
  • STRIPS are eligible for inclusion in tax-deferred retirement plans, in which their value would grow tax-free until your retirement.

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Who Buys STRIPS?

  • Because of the guaranteed cash flows at maturity, many institutions buy these securities. Eg Pension funds, insurance companies, banks, and retail investors

 

 

Author: Trushali Hindocha

About the Author: Trushali completed her graduation in Computer science and engineering, She has worked as an Associate Consultant in Atos Syntel for 18 months. She is currently pursuing MMS in Finance from KJ Somaiya Institute of Management Studies and Research, Mumbai. She is also well aquatinted with Tableau and programming languages like Python and R for Data Analytics.

 

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Functioning of Credit Default Swaps

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