What is a Strip Bond?

A strip bond, also known as a zero-coupon bond, is a fixed-income security that does not pay periodic interest (coupon payments). Instead, it is sold at a deep discount and repaid at its full face value at maturity. This means investors earn a return from the difference between the purchase price and the maturity value.

How a Strip Bond Works

Unlike regular bonds that pay interest, strip bonds are created by separating (or “stripping”) the interest payments from the principal. Each component (coupon payments and principal) is treated as a separate bond.

For example:

• A 10-year bond with a £1,000 face value and a 5% annual coupon can be stripped into:
  • 10 individual coupon payments (each worth £50)
  • 1 principal repayment of £1,000

Each of these is sold separately as a strip bond, providing fixed payouts at different maturity dates.

Key Features of a Strip Bond

• No Regular Interest Payments: All returns come from capital appreciation.
• Sold at a Discount: Investors buy the bond for less than its face value.
• Fixed Maturity Value: The bondholder receives full face value at maturity.
• Sensitive to Interest Rates: Strip bonds react more strongly to rate changes than regular bonds.

Advantages of Investing in Strip Bonds

• Predictable Returns: Since there are no reinvestment risks, investors know exactly how much they will receive at maturity.
• Long-Term Planning: Ideal for investors saving for future expenses like retirement or education.
• Low Maintenance: No need to reinvest coupon payments.

Risks of Strip Bonds

• Interest Rate Risk: Higher sensitivity to rate changes compared to regular bonds.
• Inflation Risk: Fixed payouts may lose purchasing power over time.
• Liquidity Risk: Some strip bonds have lower market demand, making them harder to sell before maturity.

Strip Bonds vs. Other Bonds

Feature	Strip Bond	Straight Bond	Convertible Bond	Treasury Bond
Pays Interest?	No	Yes	Yes	Yes
Sold at a Discount?	Yes	No	No	No
Higher Interest Rate Sensitivity?	Yes	No	No	No
Reinvestment Risk?	No	Yes	Yes	Yes

FAQs

What is a strip bond?

A strip bond is a zero-coupon bond sold at a discount and redeemed at face value upon maturity.

How do strip bonds differ from regular bonds?

Regular bonds pay interest, while strip bonds provide returns only through price appreciation.

Are strip bonds risk-free?

They are considered low-risk if issued by governments, but they still carry interest rate and inflation risks.

Can strip bonds be sold before maturity?

Yes, but their value fluctuates based on interest rate changes.

Who issues strip bonds?

Governments, corporations, and financial institutions issue strip bonds.

Are strip bonds good for retirement savings?

Yes, they are ideal for long-term investors looking for predictable, lump-sum payouts.

How are strip bonds taxed?

Even though they don’t pay interest, investors may owe taxes on the implied interest (accrued discount).

Why do strip bonds react strongly to interest rates?

Since they don’t pay periodic interest, all returns depend on the discount-to-maturity value, making them highly sensitive to rate movements.

Can strip bonds be used in portfolio diversification?

Yes, they provide fixed-income stability and complement other investments like stocks and regular bonds.

Are strip bonds available for all maturities?

Yes, they are available for short, medium, and long-term durations.