STRIPS (Separate Trading of Registered Interest and Principal)
STRIPS (Separate Trading of Registered Interest and Principal of Securities) are zero-coupon securities created by separating the individual coupon payments and the principal repayment of a government bond into standalone tradeable instruments, each maturing on specific dates, allowing investors to construct precise cash flow matching strategies and creating a term structure of zero-coupon rates from government bonds.
The Reserve Bank of India introduced a STRIPS framework for Government Securities in April 2010, enabling the separation of standard coupon-paying G-Secs into individual zero-coupon bonds. Under this framework, a 10-year G-Sec paying semi-annual coupons can be stripped into 20 individual coupon strips (each representing one semi-annual payment) plus one principal strip (representing the face value repayment at maturity), creating 21 separately tradeable zero-coupon securities with maturities ranging from 6 months to 10 years.
The mechanics of stripping are conducted through the RBI's Negotiated Dealing System (NDS). Authorised entities — primary dealers and scheduled commercial banks — can request stripping of eligible G-Secs, converting a coupon bond into multiple STRIPS. The reverse process (reconstitution) allows separate STRIPS to be recombined back into the original coupon bond, as long as all components are assembled in the correct face value proportions. This arbitrage mechanism ensures that STRIPS pricing remains broadly consistent with coupon bond prices; if STRIPS are mispriced relative to their coupon bond equivalents, dealers can strip or reconstitute to capture the difference.
Zero-coupon STRIPS have several distinctive properties that make them valuable for specific applications. First, there is no reinvestment risk — because there are no intermediate cash flows to reinvest, the investor's return from a STRIP equals exactly the yield at purchase, held to maturity. This makes STRIPS ideal for liability matching: an insurer, pension fund, or provident fund with known future payment obligations can purchase STRIPS maturing on exactly those dates, eliminating both reinvestment risk and price risk if held to maturity. Second, STRIPS exhibit higher duration than equivalent-maturity coupon bonds because the entire cash flow is concentrated at maturity, making STRIPS highly sensitive to interest rate movements — a feature valued by active duration traders.
Pricing of STRIPS is based on the present value of a single future cash flow: Price = Face Value / (1 + r)^n, where r is the semi-annual yield and n is the number of semi-annual periods to maturity. This makes the relationship between price and yield perfectly transparent. The Indian zero-coupon yield curve — constructed from STRIPS prices — provides the building blocks for derivative pricing, bond valuation, and discounting of future obligations in actuarial calculations.
The STRIPS market in India remains relatively thin compared to the US Treasury STRIPS market, which accounts for several trillion dollars of outstanding strips. Indian STRIPS activity is primarily institutional, with banks and primary dealers using them for balance sheet management and duration positioning. Retail investor access to STRIPS is limited as the typical lot sizes are large and secondary market liquidity is constrained. However, the RBI Retail Direct framework does not explicitly exclude STRIPS, and as market infrastructure matures, retail access may expand.