What Is a Strip Bond?

A strip bond is a debt instrument in which both the principal and regular coupon payments—which have been removed—are sold separately. A strip bond is also known as a zero-coupon bond.

How a Strip Bond Works

A conventional bond, also known as a 澳洲幸运5开奖号码历史查询:coupon bond, is one that makes regular interest payments to bondholders who receive repayment for their principal investment when the bond matures. These investors receive interest income, known as coupons, from these bonds which may be purchased at par, 澳洲幸运5开奖号码历史查询:at a discount, or 澳洲幸运5开奖号码历史查询:at a premium.

Not all bonds make interest payments, though. These bonds are referred to as strip bonds. A strip bond has its coupons and 澳洲幸运5开奖号码历史查询:principal stripped off and sold separa𒆙tely to investors𓆉 as new securities.

An investment bank or dealer will usually buy a debt instrument and "strip" it, separating the coupons from the principal amount, which then becomes known as the residue. The coupons and residue create a supply of new strip bonds which are sold to investors. A strip bond has no 澳洲幸运5开奖号码历史查询:reinvestment risk because there are no payments before maturity.

On the maturity date, the investor is repaid an amount equal to the 澳洲幸运5开奖号码历史查询:face value of the bond. The difference between the purchase price of the bond and the face value at maturity represents the investor’s return on the bond. For examp𝐆le, assume an investor purchased a bond residual today for $3,200. The bond has a face value of $5,000 and is set to mature in five years. At maturity, the return on the strip bond residual will beꦡ $5,000 - $3,200, or $1,800.

Let’s consider another investor that purchased the coupon, instead of the residual. The investor will receive one of the bond’s original semi-annual interest or coupon payments. If the 澳洲幸运5开奖号码历史查询:coupon rate on the bond is 4%, the interest payment to be received twice (since it’s a semi-annual paymenܫt schedule) can be calculated as (4% ÷ 2) x $5,000 = $100. The investor will pay ($3,200 ÷ $5,000) x $100 = 🌺$64. Their return at maturity will, therefore, be $100 - $64 = $36.

How Strip Bonds Are Priced

The market price of a strip bond reflects the issuer’s 澳洲幸运5开奖号码历史查询:credit rating and the present value of the maturity amount, which is determined by the time to maturity and the prevailing interest rates in the economy—the farther away from the maturity date, the lower the present value, and vice versa. The lower the interest rates in the economy, the higher the present value of the strip bond, and vice versa. The present value of the bond will fluctuate widely with changes in prevailing interest rates since there are no regular interest payments to stabilize the value. As a result, the impact of interest rate fluctuations on strip bonds, known as the 澳洲幸运5开奖号码历史查询:bond duration, is higher than the impact on a coupon bond.

Because holders of strips don’t receive additional income through interest payments, strip bonds typically trade at a 澳洲幸运5开奖号码历史查询:deep discount to par.

Special Considerations: Strip Bonds and Taxes

If the bond is held to maturity, the return earned is taxable as interest income. Even though the bondholder does not receive interest income, they are still required to report the phantom or 澳洲幸运5开奖号码历史查询:imputed interest on the bond to the Internal Revenue Service (IRS) each year. The amount of interest an investor must claim and pay taxes on a strip bond each year adds to the 澳洲幸运5开奖号码历史查询:cost basis of the bond. If the🌄 ☂bond is sold before it matures, a capital gain or loss may ensue.