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, the $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. When is a bond's coupon rate and yield to maturity the same?

    Find out when a bond's yield to maturity is equal to its coupon rate, and learn about the components of bonds and how they ... Read Answer >>
  2. What does it mean if a bond has a zero coupon rate?

    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 >>
  3. If I buy a $1,000 bond with a coupon of 10% and a maturity in 10 years, will I receive ...

    See how fixed-income security investors can expect to use coupon rates on semi-annual payments if the bond or debt instrument ... Read Answer >>
  4. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
Related Articles
  1. Investing

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  2. Financial Advisor

    Calculate PV of different bond type with Excel

    To determine the value of a bond today — for a fixed principal (par value) to be repaid in the future — we can use an Excel spreadsheet.
  3. Investing

    The Benefits of a Bond Portfolio

    Bonds are often viewed as stocks' less-glamorous sidekick, but they deserve more respect from investors. Learn how a fixed-income portfolio works.
  4. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  5. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  6. Financial Advisor

    How Rising Rates Impact Bond Mutual Funds

    The interest rate increase by the Fed was one of the most widely anticipated in history. Here's what it means for bond mutual funds.
  7. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
RELATED TERMS
  1. Strip Bond

    A strip bond is a bond where both the principal and regular coupon ...
  2. Treasury STRIPS

    Treasury STRIPS are an acronym for 'separate trading of registered ...
  3. Certificate Of Government Receipts - COUGRs

    Certificates of Government Receipts are one of several synthetic ...
  4. Bond Discount

    Bond discount is the amount by which the market price of a bond ...
  5. Straight Bond

    A straight bond is a bond that pays interest at regular intervals, ...
  6. Short Coupon

    A short coupon is a payment made on a bond within a shorter time ...
Trading Center