What is a STRIP in your financial assets?

STRIP is an acronym that is commonly used to denote ‘Separate Trading of Registered Interest and Principal of securities’. This is a complex-sounding term however, in reality, the meaning is quite simple. STRIPS are the securities created by way of separating the cash flows associated with a regular G-Sec i.e. each semi-annual coupon payment and the final principal payment to be received from the issuer, into separate securities. They are essentially Zero Coupon Bonds (ZCBs), however, they are created out of existing securities only and unlike other securities, are not issued through auctions.

Conventional bonds have two parts, the face value, or principal, and the coupons (interest). The strip bond (Zero Coupon Bond) is a hybrid fixed-income investment created when a standard bond is deconstructed. For example, when ₹1000 of the 8.00% G-Sec 2028 is stripped, each cash flow of coupon (₹ 40.00 each half year i.e. (Rs1000 x 8.00% / 2)) will become a coupon STRIP and the principal payment ₹1000 will become a principal STRIP payable on maturity. These cash flows are traded separately as independent securities in the secondary market. Treasury Bills (T-Bills) issued by the Reserve Bank of India (RBI) are also zero coupon bonds.

STRIPS in G-Secs ensure the availability of sovereign zero coupon bonds, which facilitate the development of a market-determined zero coupon yield curve (ZCYC). All fixed coupon securities issued by the Government of India, irrespective of the year of maturity, are eligible for Stripping/Reconstitution, provided that the securities are reckoned as an eligible investment for Statutory Liquidity Ratio (SLR) and the securities are transferable.

It is important to understand here that when we buy a bond that pays regular coupon payments, we are buying the right to receive a series of cash flows. In the case of a Strip Bond, it does not make periodic interest payments or “coupons” to the investors. For instance, if we buy a 5-year bond that pays a semi-annual coupon, we are buying the right to receive coupon payments on ten separate occasions and also one principal payment. In other words, the buyer receives eleven separate payments. The STRIP bonds however convert this one single bond into eleven different securities traded separately as independent securities in the secondary market.

STRIPS bonds are cheaper as they are bought at a discount, increasing their appeal versus normal securities. STRIPS also provide institutional investors with an additional instrument for their asset liability management (ALM). Further, as STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors, as the investor earns from the difference between the issue price and the maturity price of the bonds.  The longer the maturity period, the lower the price the investor would pay to purchase these bonds.

 STRIPS also provides institutional investors with an additional instrument for their asset liability management (ALM). Further, as STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors. Trading volume in STRIPS hit 1.3 trillion rupees in the last financial year. Traders expect them to be around 2 trillion rupees in the current year.

Market participants, having an SGL account with RBI can place requests directly in e-kuber for stripping/reconstitution of eligible securities (not special securities). Requests for stripping/reconstitution by Gilt Account Holders (GAH) shall be placed with the respective Custodian maintaining the CSGL account, who in turn, will place the requests on behalf of its constituents in e-kuber.