Definition of Stripped Coupon
A stripped coupon, sometimes referred to simply as a strip, pertains to a smaller segment of a larger security, typically bonds. In the context of U.S. Treasury securities, it commonly relates to Separately Traded Registered Interest and Principal Securities (STRIPS). These are debt securities where the interest payments (coupons) and the principal amounts are sold separately as zero-coupon securities.
Examples
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U.S. Treasury STRIPS: An investor buys the interest payments from a Treasury bond separately from the principal amount. The coupons and principal are sold individually, each becoming a zero-coupon security.
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Corporate Bonds: Similarly, corporate bonds can be stripped of their interest payments and principal, both parts trading independently in the secondary market.
Frequently Asked Questions
1. What are the benefits of investing in stripped coupons (STRIPS)?
Investors find STRIPS attractive due to their predictability in terms of payment since they are sold at a discount and mature at face value.
2. Can stripped coupons be sold before maturity?
Yes, stripped coupons can be traded in the secondary market before their maturity date, providing investors with liquidity.
3. How are STRIPS taxed?
While STRIPS do not pay interest periodically, the accrued interest (imputed interest) is nevertheless taxed annually.
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Zero-Coupon Bond: A bond that does not pay periodic interest. It is sold at a discount to its face value and provides a return at maturity when the full face value is paid.
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Coupon Bond: A bond that pays regular interest payments, known as coupons, to the bondholder until maturity, when the face value is also repaid.
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Principal-Only (PO) Strip: A type of strip where only the bond’s principal repayment section is available for trading.
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Interest-Only (IO) Strip: Refers to securities where only the bond’s regular coupon payments are sold independently from the principal repayment.
Online References
Suggested Books for Further Studies
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi
- “Bond and Money Markets: Strategy, Trading, Analysis” by Moorad Choudhry
Fundamentals of Stripped Coupon: Fixed Income Basics Quiz
### What is a stripped coupon?
- [ ] A coupon offered by a store
- [ ] A bond only sold to institutional investors
- [x] A security with the interest payments and principal sold separately
- [ ] A type of high-yield bond
> **Explanation:** A stripped coupon refers to bonds where the interest payments and principal are sold independently as separate securities.
### What are STRIPS in the context of U.S. Treasury bonds?
- [ ] Entire bonds with monthly interest
- [x] Separated components of the bonds sold individually as zero-coupon securities
- [ ] Bonds with quarterly dividends
- [ ] Bonds that cannot be traded in secondary markets
> **Explanation:** STRIPS are U.S. Treasury bonds separated into interest and principal components and sold as individual zero-coupon securities.
### What type of bonds do stripped coupons resemble?
- [ ] Variable rate bonds
- [ ] Convertible bonds
- [x] Zero-coupon bonds
- [ ] Inflation-linked bonds
> **Explanation:** Stripped coupons function like zero-coupon bonds since they are sold at a discount and do not make periodic interest payments.
### What is a principal-only (PO) strip?
- [ ] A bond segment that includes only interest payments
- [ ] A security offering variable interest annually
- [x] A stripped security containing only the repayment of the bond's principal
- [ ] A bond segment unaffected by market fluctuations
> **Explanation:** A principal-only (PO) strip refers to a bond segment comprising just the principal repayment, sold without the coupon payments.
### How often are interest payments made on stripped coupons?
- [ ] Monthly
- [ ] Quarterly
- [ ] Annually
- [x] They are not made; interest is accrued and taxed annually.
> **Explanation:** Stripped coupons do not make regular interest payments; instead, accrued interest is imputed annually and taxed accordingly.
### What is another name for a security like stripped coupons?
- [ ] High-yield bond
- [x] Zero-coupon security
- [ ] Variable interest bond
- [ ] Convertible bond
> **Explanation:** Stripped coupons can be referred to as zero-coupon securities as they do not pay periodic interest but mature at face value.
### Who issues STRIPS in the United States?
- [ ] Corporate firms
- [ ] Municipal governments
- [x] U.S. Treasury
- [ ] Private banks
> **Explanation:** The U.S. Treasury is responsible for issuing STRIPS by separating the principal and interest components of its bonds for investors.
### What is an interest-only (IO) strip?
- [x] A stripped security containing only the periodic interest payments
- [ ] A zero-coupon bond
- [ ] A security paid upon bond maturation
- [ ] A synthetic bond product
> **Explanation:** An interest-only (IO) strip refers to a stripped bond containing only the periodic interest payments, excluding the principal repayment.
### How are the prices of STRIPS typically set?
- [ ] Based on market demand every quarter
- [x] Sold at a discount to face value
- [ ] At par value, adjusted for inflation
- [ ] Priced equivalent to junk bonds
> **Explanation:** STRIPS, like zero-coupon bonds, are typically sold at a discount to their face value, reflecting the absence of periodic interest payments.
### How does interest rate risk affect a stripped coupon?
- [ ] It has no impact on stripped coupons.
- [ ] Decreases attractiveness as interest rates rise
- [x] Increases its sensitivity due to long duration
- [ ] Reduces value only marginally compared to corporate bonds
> **Explanation:** Stripped coupons have a heightened sensitivity to interest rate changes due to their long duration and absence of periodic interest payments.
Thank you for exploring the fundamentals of stripped coupons and enhancing your financial knowledge. Stay curious and informed!
