Summary of this article
STRIPS offer fixed payouts divided into cash flows of a particular bond
Know how STRIPS work and how investors can buy them
Separate Trading of Registered Interest and Principal Securities (STRIPS) are fixed income instruments that are created by stripping a regular bond in different parts according to its cash flow. Any standard bond has two components – the principal amount of the bond issued which is paid back at the time the bond matures or is redeemed, and the interest rate or the coupon rate paid either annually or biannually to the holder of the bond till the time it matures. In STRIPS, the final principal repayment and the coupons are independently traded similar to zero coupon securities. Similar to a zero coupon bond, STRIPS offer a deep discount to the face value of the bond, with the profit for the investor being the difference between the face value of the bond and the price at which the investor buys it.
The Reserve Bank of India has allowed the trade of STRIPS of government dated securities (G-secs), including state government securities . For state government bonds, the RBI has mandated that the particular bond being stripped must have a maturity of at least 14 years and have a market outstanding of a minimum of Rs. 1,000 crore.
Currently, there are Rs. 8.81 lakh crore worth of G-sec STRIPS outstanding in the market which include both the principal securities and the coupons. Most STRIPS are for long term security, but some institutional investors also demand shorter tenure securities maturing in five years to lock in the returns against certain payments requirements.
How do STRIPS work?
STRIPS are typically bought by investors who are looking for simple and fixed returns and do not want to face market volatility. An investor buying STRIPS for just the principal amount will be able to buy the instruments at a much discounted rate since the regular coupon repayment is not attached. The significant discount to the face value that the investors get while buying the instrument at the time of redemption of the bond becomes the full face value, thereby giving the investor a natural appreciation of its value over time.
Since STRIPS in India are so far allowed in government securities primarily, the nature of your investment is secured. It is also a predictable investment since there is no risk of reinvestment. It provides easy computing for investors to precisely match their investments in accordance with any future liabilities that may arise.
For an investor looking for a long-term investment with a fixed return and a specific maturity, STRIPS can be one of the many ways of adding debt-linked assets to their portfolio. STRIPS with a 10-year maturity can give a return ranging between 7 to 8 per cent annually. Investments in STRIPS offer return on investment by compounding the accrued coupon payments with the initial investment amount.
For a retail investor, STRIPS are available on the RBI’s direct retail portal. An investor can also find these STRIPS on online bond platforms registered with the Securities and Exchange Board of India (Sebi).
