Definition of Gilt Strip
A gilt strip (or ‘gilt-edged security strip’) is a type of UK government stock that has been issued by the Bank of England since 1996. Essentially, gilt strips are bonds that have been broken down into their individual interest (coupon) payments and the principal repayment. Each of these cash flows is then sold separately at a discount to face value. These instruments are a form of fixed income investment allowing investors to buy specific interest payments or the principal repayment separately, providing different maturities and cash flow structures to meet various investment needs.
Examples of Gilt Strips
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Coupon Strip Example: If an investor purchases a coupon strip of a 10-year UK Gilt, they are buying the right to receive one of the semi-annual interest payments that the bond would normally yield. These individual payments are sold at a discount, meaning the investor will pay less than the value they will receive in the future.
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Principal Strip Example: If an investor buys the principal strip, they are purchasing the right to receive the final principal payment at the maturity of the bond. Again, this would be bought at a discount to its face value.
Frequently Asked Questions (FAQs) about Gilt Strips
Q1: What is the primary benefit of investing in gilt strips? A1: The primary benefit is the ability to manage interest rate risk and match cash flows to specific future liabilities. Investors can buy strips for specific cash flow requirements.
Q2: Can all gilts be stripped? A2: No, stripping is typically available for standard UK government bonds that are suitable for the stripping process. Not all gilts qualify for this treatment.
Q3: How are gilt strips taxed? A3: The taxation on gilt strips depends on the investor’s location and tax laws but usually, the interest component is subject to income tax, while capital gains may have different tax implications.
Q4: What is the difference between a gilt and a gilt strip? A4: A gilt is a standard government bond with regular coupon payments and a principal repayment at maturity. A gilt strip is a component of a gilt, separated into individual coupon payments or the principal amount, sold independently.
Q5: How is liquidity in gilt strips compared to standard gilts? A5: Gilt strips generally have lower liquidity compared to standard gilts due to a smaller investor base and the specialized nature of these instruments.
Related Terms with Definitions
- Gilt: A UK government bond typically considered a low-risk investment because it is backed by the UK government.
- STRIPS (Separate Trading of Registered Interest and Principal of Securities): A U.S. Treasury program that similarly allows individual interest and principal payments on Treasury securities to be purchased and sold separately.
- Zero-Coupon Bond: A bond that does not pay periodic interest and is sold at a discount to its face value, with the principal paid at maturity.
- Fixed Income Security: An investment that provides return in the form of fixed periodic payments and the return of principal at maturity.
Online References
Suggested Books for Further Studies
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi
Accounting Basics: “Gilt Strip” Fundamentals Quiz
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