STRIPS stands for Separate Trading of Registered Interest and Principal of Securities. It is a type of zero-coupon bond created by stripping the interest payments (coupons) and the principal payment from a traditional Treasury bond into two separate entities which are then sold individually.
What Are STRIPPED COUPONS?
A stripped coupon refers to the individual interest payments that have been separated from the principal of a bond. In a stripped bond, these coupons are sold separately from the principal payment, allowing investors to purchase specific portions of the bond’s cash flows.
Understanding Stripping Process
Treasury Securities
When Treasury securities are stripped, the process creates two types of securities:
- Coupon STRIPS: These represent the interest payments.
- Principal STRIPS: These represent the principal repayment at maturity.
Historical Context
The U.S. Department of the Treasury introduced STRIPS in 1985 to improve market liquidity and provide investors with more flexibility in managing their investments. By separating coupons from principal payments, investors could target specific cash flows that meet their financial goals.
Applicability to Investors
STRIPS offer unique benefits to certain types of investors including:
- Pension Funds: Targeting specific future payout dates.
- Insurance Companies: Matching the durations of liabilities.
- Individual Investors: Seeking to lock in a fixed return for a future need.
Comparisons and Related Terms
Zero-Coupon Bonds
Like STRIPS, zero-coupon bonds are sold at a discount and do not make periodic interest payments. However, they differ because STRIPS are derived from traditional bonds, whereas zero-coupon bonds are issued directly as such.
Treasury Bond
A Treasury Bond is a long-term, interest-bearing bond issued by the U.S. Department of the Treasury with maturity periods of up to 30 years, from which STRIPS are derived.
FAQs
Q1: How does the taxation of STRIPS work? A1: STRIPS are taxed annually on their imputed interest, similar to zero-coupon bonds, even though the investor does not receive this interest until maturity.
Q2: Can I reintegrate my STRIPS into a single bond? A2: No, once a Treasury bond is stripped, the components (coupons and principal) are traded separately and cannot be recombined into the original bond.
References
- U.S. Department of the Treasury. (1985). Introduction to STRIPS Program.
- Investopedia. (n.d.). STRIPS Definition. Retrieved from Investopedia
Summary
STRIPPED COUPONS refer to the separated interest payments from a bond within the STRIPS program. By understanding the structure, benefits, and applicable contexts, investors can utilize STRIPS to meet specific financial goals, benefiting from the flexibility and targeted cash flows offered by these financial instruments.
For more information, please visit the entry on STRIPS.
