What is 'Coupon Stripping'
Coupon stripping is the separation of a bond's periodic interest payments from its principal repayment obligation to create a series of individual securities. In coupon stripping, the underlying bond becomes a zero-coupon bond and each interest payment becomes a separate zero-coupon bond. Each bond will sell at a different discount to face value based on its time to maturity.
BREAKING DOWN 'Coupon Stripping'
If an investment bank held a $50 million Treasury bond that paid 5% interest annually for five years, coupon stripping would turn that bond into six new zero-coupon bonds: one $50 million bond that matured in five years and five $2.5 million bonds that would each mature in one of the coming five years. Coupon stripping can also divide up a larger bond with a particular interest rate into a series of smaller bonds with different interest rates to satisfy investors' demands for particular types of bonds. This practice is seen in the mortgage-backed security market.