A:

The quick answer to this question is that a stripped bond is a bond that has had its main components broken up into a zero-coupon bond and a series of coupons.

To help explain one, let's first describe a bond. A bond is a debt instrument traditionally comprised of two parts, the face value (principal) and the coupons (interest rate). The face value of the bond is the amount received by the bondholder at maturity. The coupon refers to a fixed-interest payment made to the bondholder at predetermined intervals.

A stripped bond is a bond that has had its coupon payments and principal repayment stripped into two separate components and sold individually. One party will receive the principal at maturity (zero-coupon bond) and the other party will receive the fixed-interest payment over the life of the bond in the form of a stream of coupons.

Let's take a look at a simplified stripped bond example. Suppose Cory's Tequila Co needs to raise capital to finance a new distillery. It decides the best way to do this is to issue bonds, which are sold with a face value of $1,000, a coupon payment of 5% paid annually and matures in five years. Ben's Investment Co is in the business of bond stripping and buys the bond for $1,000 and then strips out the coupons. If Ben's sells the principal-stripped bond for $800 to an investor and the coupon payments for $200 to another investor. This $200 and the $800 received will make Ben's break even on the purchase of the bond. The individual with the coupon-stripped bond will get the par value of $1,000 at the end of the five years from Cory's Tequila Co, making a profit of $200. And the purchaser of the coupons will pay $200 to receive $250, meaning they make $50 off the purchase. By providing this investment service, Ben's would receive a commission on the sale of these two stripped bonds.

There are additional factors to consider. The price that Ben's Investment Co can sell the face value of the bond will depend on the prevailing interest rates at the time of sale. It may also sell off the coupon payments to other investors. In the example, Ben's breaks even and receives no return on its investment. Companies that do this make money based on selling at a premium to do the stripping service along with any gain it makes from the difference between the selling price on either the face value or coupon payments compared to what they initially paid for the bond.

For further reading, see Advantages of Bonds and our tutorials Bond Basics Tutorial and Advanced Bond Concepts.

RELATED FAQS
  1. How does a bond's coupon interest rate affect its price?

    Find out why the difference between the coupon interest rate on a bond and prevailing market interest rates has a large impact ... Read Answer >>
  2. How does a bond's coupon rate affect its price?

    Find out how a bond's coupon rate influences its price, including the role of government-dictated interest rates and the ... Read Answer >>
  3. How do debit spreads impact the trading of options?

    Find out what it means when a bond has a coupon rate of zero and how a bond's coupon rate and par value affect its selling ... Read Answer >>
  4. What is the difference between a zero-coupon bond and a regular bond?

    The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons, or interest ... Read Answer >>
  5. If I buy a $1,000 bond with a coupon of 10% and a maturity in 10 years, will I receive ...

    Simply put: yes, you will. The beauty of a fixed-income security is that the investor can expect to receive a certain amount ... Read Answer >>
  6. Can the marginal propensity to consume ever be negative?

    Find out when a bond's yield to maturity is equal to its coupon rate, and learn about the basic components of bonds and how ... Read Answer >>
Related Articles
  1. Investing

    Introduction To STRIPS

    STRIPS provide an alternative form of bond for fixed-income investors who need definite cash flows at specific times. Read the article to find out how.
  2. Personal Finance

    ‘Retired’ Too Soon? How to Reenter the Workforce After 50

    Here's what you need to know to survive financially and reenter the workforce when you're over 50 and a layoff has forced you to "retire" too soon.
  3. Investing

    How Does A Bond’s Coupon Interest Rate Affect Its Price?

    All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays.
  4. Financial Advisor

    Using Excel PV Function to compute Bonds PV

    To determine the value of a bond today - for a fixed principal (par value) to be repaid in the future at any predetermined time - we can use an Excel spreadsheet.
  5. Investing

    What are Treasury STRIPS?

    STRIPS is an acronym that stands for Separate Trading of Registered Interest and Principal Securities.
  6. Investing

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  7. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  8. Investing

    What is a "Coupon"?

    In the financial world, “coupon” represents the interest rate on a bond.
RELATED TERMS
  1. Coupon Stripping

    The separation of a bond's periodic interest payments from its ...
  2. Strip

    1. For bonds, the process of removing coupons from a bond and ...
  3. Treasury STRIPS

    An acronym for 'separate trading of registered interest and principal ...
  4. Zero-Coupon Bond

    A debt security that doesn't pay interest (a coupon) but is traded ...
  5. Coupon Bond

    A debt obligation with coupons attached that represent semiannual ...
  6. Current Coupon Bond

    A bond with a coupon rate that is within 0.5\% of the current ...
Hot Definitions
  1. Dumping

    In international trade, the export by a country or company of a product at a price that is lower in the foreign market than ...
  2. Tender Offer

    An offer to purchase some or all of shareholders' shares in a corporation. The price offered is usually at a premium to the ...
  3. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
  4. Dow Jones Industrial Average - DJIA

    The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange ...
  5. Revolving Credit

    A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is ...
  6. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
Trading Center