Strip Bond

⸺ by Charles Iliya Krempeaux

A strip bond is a where the yield is stripped away (and you don't get it), but you buy the for less than its principal amount.

Example

Let's use an example to try to make this clearer.

Let's say that you are the holder of a that you got 1 year ago. That you lent the issuer of the $10,000,000. That the maturity date 2 years from now (of which 1 year has already passed). And that after 2 years, in addition to being paid back all of the $10,000,000 you lent them (i.e., the principal) that you will also be paid an extra $1,400,000 (i.e., the yield). But 1 year is a long time. What you want your money now — not just your principal but also your yield. Well, the issuer isn't going to give it to you — you alredy agreed to wait 2 years. (And the issuer already has other plans for the money, and has put it into use.) So, how do you get your money now?

Here is a way. Since you have already waited 1 year, after 2 years, the will pay you back your principal plus your yield. So, it will pay you back —

$11,400,000 = $10,000,000 + $1,400,000

What if you let someone else buy your from you‽ What if you sold it for $10,600,000‽

You would get your $10,000,000 (i.e., your principal) back, plus you would also get an extra $600,000 (i.e., part of the yield). You now have a lot of money again, to do with as you please.

If the buyer of this is OK with leaving their money in it for 1 years, they will be paid the original $11,400,000 that you were supposed to have been paid. Which means they get back the $10,600,000 they bought it from you from, plus another $800,000. That is a better performance than them buying the themselves.

In this example, the thing that the buyer bought from you is a called a strip bond.