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. 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 >>
  2. What is the difference between yield to maturity and the coupon rate?

    A bond's coupon rate is the actual amount of interest income earned on the bond each year based on its face value. Read Answer >>
  3. How does an investor make money on bonds?

    Bonds are part of fixed-income securities called debt obligations, meaning one party borrows from another party who expects ... Read Answer >>
  4. Learn to Calculate Yield to Maturity in MS Excel

    Find out the best practices for most financial modeling to price a bonds, calculate coupon payments, then learn how to calculate ... 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

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  4. Investing

    Bond Portfolios Made Easy

    Bonds have typically been viewed as stocks' less-glamorous sidekick, but they deserve a little more respect from investors.
  5. Investing

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
  6. Investing

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  7. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  8. Managing Wealth

    How Bond Prices and Yields Work

    Understanding bond prices and yields can help any investor in any market.
RELATED TERMS
  1. Strip Bond

    A strip bond is a bond where both the principal and regular coupon ...
  2. Certificate Of Government Receipts - COUGRs

    Certificates of Government Receipts are one of several synthetic ...
  3. Short Coupon

    A short coupon is a payment made on a bond within a shorter time ...
  4. Discount Bond

    A discount bond is a bond that is issued for less than its par ...
  5. Income Bond

    An income bond is a type of debt security in which only the face ...
  6. Variable Rate Demand Bond

    A variable rate demand bond is a municipal bond with floating ...
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  3. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  4. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  5. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  6. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
Trading Center