Treasury Bond STRIPS are zero-coupon bonds STRIPPED from regular coupon paying Treasury Securities.
Zero - Coupon bonds are simply bond instruments that pay no interim cash flows. The
zero coupon bond is the most simple type of transaction involving only two cash flows:
• Money Invested Now (at discount)
• Money Returned at Maturity (face amount)
As bonds have a typical life longer than one year we tend to compare them on the basis of Yield to Maturity. The YTM of a zero coupon bond is a relatively simple concept that we will deal with in the next few paragraphs.
- The annual YTM of a five year zero coupon bond is simply the answer to the following question: What rate of interest would I need to earn on each of a series of successive one year investments such that my proceeds at the end of five years would be the same as they would be from having invested in the five year zero coupon bond?
- On occasion a similar question might be asked with the intention of ascertaining the 'Semi - Annual' YTM of a five year zero coupon bond: What rate of interest would I need to earn on each of a series of successive half - year investments such that my proceeds at the end of five years would be the same as they would be from having invested in the five year zero coupon bond? This half - yearly rate of return is, by market convention, then simply doubled so as to provide a yearly equivalent.
- More detail can be found on this at www.davidandgoliathworld.com