STRIPS (Separate Trading of Registered Interest and Principal of Securities) are instruments in which a fixed-coupon government bond is broken down ("stripped") into its separate cash flows: each coupon payment and the principal repayment become individual zero‐coupon securities.
For example, a government bond pays coupons every six months from the issue date, along with the principal at maturity. After the bond is stripped, each coupon is turned into a separate tradable instrument called a “Coupon STRIP,” while the principal is converted into another instrument known as the “Principal STRIP.”
The STRIPS carry only one cash flow (usually at maturity), they behave like zero‐coupon bonds: you buy them at a discount, and you receive the face value at maturity.
Features of Strips
Zero Coupon Bond: Each individual principal or interest payment is treated as a distinct zero-coupon bond. Strips are issued at a discount to their face value and redeemed at face value on the maturity without any periodic interest payments.
No Interest Payout: Since Strips securities behave like zero coupon bonds, there is no cashflow in the between in the form of coupons. You receive the face value amount at the maturity.
Underlying: STRIPS are created from the existing fixed coupons and tradable government securities (G-Secs) issued by both Central and State Government Securities (SGSs).
Face Value: The Face value of Treasury bills is same as other government securities i.e. Rs 100.00
Minimum Investment: The minimum investment in the STRIPS is Rs. 10,000 and can be purchased in multiple of 10,000
Tradability: STRIPS needs to be purchased from the secondary market as the same is not issued by the government through the primary market
Tax Implications: The annual accrued gain (difference between the discounted purchase price and face value at maturity) may be subject to tax according to accrual accounting methods, even if the cash is received only at maturity. However, we advise you to verify with your tax consultant related to tax implications on STRIPS if held until maturity, as well as the capital gains tax applicable if they are sold in the secondary market
Practical Example & Simplified Illustration
Suppose there’s a Central Government bond that pays a coupon of 7.00 % semi-annually, maturity in 10 years, face value of the security ₹100. The Holding of bond in F. V. is of Rs 1,00,00,000
In STRIPS:
Each semi-annual coupon of Rs 3,50,000 (calculated as 3.50% of Rs 1,00,00,000) is converted into a separate "Coupon STRIP," with maturity on each coupon date. In this case, there will be 20 Coupon STRIPs, each corresponding to one of the 20 semi-annual coupon payments.
The Rs 1,00,00,000 principal amount is converted into a "Principal STRIP," maturing at the end of the 10th year.’
Suppose you buy the Principal STRIP for ₹ 1,00,00,000 in face value at a price of Rs 49.00 today (just an illustration) that matures at 10 years, your annual yield retrun is approx. 7.26% and your earn Rs 51,00,000 (Rs100-49) *(1,00,00,000/100).
Because you have locked in that payout, you don’t worry about reinvesting coupons, but you accept that you’ll only get money at maturity, and the price you pay is sensitive to rates.
Benefits of Strips
Guaranteed payout: You are certain of the amount and timing of your payout.
No risk of reinvestment: Since coupons are eliminated and you get a lump sum at maturity, you avoid the uncertainty of reinvesting coupon payments at unknown future rates
Safety: Since the underlying bond is a sovereign guaranteed instrument back by Central and State government, it is considered as the safest instrument.
Predictable Cash Flows: STRIPS offer investors a fixed payment on a predetermined future date, making them excellent for meeting all the future obligations such as retirement or children’s education planning. Marriage etc.
