EMBA Module : Fixed Income Securities & Debt Markets

By : Bharat Parulekar, G Jaishanker, Narendra Somoshi Ranjit Bhanu Satej More

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What is STRIPS
STRIPS (Separate Trading of Registered Interest and Principal of Securities) are distinct, separate securities that are created from the cash flows of a Government securities and shall consist of
i. Coupon STRIPS, where the single cash flow of the STRIPS represents a coupon flow of the original security ii. Principal STRIP, where the single cash flow of the STRIP represents the principal cash flow of the original security

ORIGIN
Country US Year 1960 Event Investment Dealers in the United States began (physically) clipping coupons from bearer government bonds and selling the individual pieces as separate securities. The STRIPS program was initiated for new Treasury securities that mature in 10 years or over and are maintained in the Federal Reserve book-entry system. A facility to permit the reconstitution of securities within the STRIPS program was established. Reconstitution enabled the reassembly of a book-entry STRIPS security previously separated into its principal and interest components into a fully constituted security September 30, 1997: The notes and bonds eligible for stripping were expanded from 10-year notes and 30-year bonds to all notes and bonds. RBI allows stripping of bonds from April 1, 2010. A notification was issued on Oct 16, 2009 providing terms and conditions for stripping/reconstitution of Government Securities.

1985

1986

1997

India

2010

How STRIPS Works?

Why do investors buy STRIPS?

STRIPS are popular with investors who want to receive a known payment at a specific future date. To reduce re-investment risk: Since there are no interest payments to be re-invested at future interest rates, the return on strip bonds is fixed at the time of purchase As substitute for guaranteed investment certificates and term deposits STRIPS provides institutional investors with an addl. Instrument for Asset Liability Mgt. Surety on ROI at time of maturity

The option to realize a capital gain, instead of interest income, if interest rates do happen to fall
To match future obligations

STRIPS in India

Government Securities Act, 2006 & Government Securities Regulations, 2007 permits stripping & reconstitution of G-Secs. The salient features of guidelines issued by RBI in January 2010 are :
Stripping/reconstitution, is permitted only in eligible G-Sec held in SGL/

CSGL accounts maintained at Public Debt Office, RBI, Mumbai. STRIPS can only be held in demat form.
Stripping/reconstitution may be done at the option of the holder at any

time from the date of issuance of a G-Sec till maturity.

All dated G-Sec having coupon payment dates on January 2 and July 2,

irrespective of the year of maturity shall be eligible for stripping/ reconstitution.

RBI will not charge any fees for stripping/reconstitution of G-Secs

STRIPS in India
The minimum amount of securities for stripping shall be Rs. 1 Crs (FV)

and multiples
STRIPS is reckoned as eligible G-Secs for SLR purposes and retain all

the characteristics of G-Sec. They will be eligible for market repo as well as repo under LAF of RBI.
STRIPS, being zero coupon securities, trade at a discount and are

redeemed at FV.
To begin with, STRIPS are tradable only in OTC market and such trades

in STRIPS need to be reported on NDS for clearing and settlement through CCIL.
Reconstitution, which is reverse of stripping, allowed. It means the

coupon and principal are reassembled into the original G-Sec.

References:
http://www.finweb.com/investing/ http://www.figuide.com- article by Chuck Rylant, CFP http://www.amritpalsingh.com-blog http://www.stripbonds.info http://nmimsbanking.com RBI Annual Report 2008-09 http://www.rbi.org.in/scripts/FAQView