Market participants use strips for a variety of strategic purposes, including creating synthetic bonds, positioning on the shape of the yield curve, and arbitraging discrepancies between the strip market and the bond market. A traditional coupon bond offers a stream of income through periodic interest payments, which can be reinvested at prevailing market rates.
What Are Strips in Finance Definition
For example, a pension fund can use a strip maturing in ten years to fund a specific pension payout that is due in that same year. To create a strip, a financial institution takes a collection of these identical bonds and separates each cash flow.
Instead, they are issued at a significant discount to their face value and pay the full face value only at their specific maturity date, which corresponds to the original cash flow they represent. These newly created strips are then sold as zero-coupon securities, meaning they do not pay periodic interest.
What Are Strips in Finance Definition and How They Work
Key Differences from Traditional Bonds While derived from bonds, strips function quite differently in the marketplace. The interest payments are grouped together to form individual coupon strips, while the final principal payment forms the principal strip.
More About What are strips in finance
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