Stripped Bond

Background

Stripped bonds, also referred to as zero coupon bonds, are financial instruments created by disaggregating the principal payment from the coupon payments of a traditional bond. The principal and coupon payments are sold separately to different investors.

Historical Context

The development of stripped bonds aligns with the innovative desires within financial markets to cater to diverse investor preferences. Initially, these bonds emerged as a product of financial engineering techniques meant to create predictable cash flows for different investment strategies and mitigating reinvestment risk.

Definitions and Concepts

Stripped Bond: An ordinary bond whose principal and interest payments have been removed and sold separately as individual securities.
Zero Coupon Bond: A type of bond that does not distribute periodic coupon payments and is sold at a discount to its face value, effectively interest accruing is implicit.

Major Analytical Frameworks

Classical Economics

Classical economic theory primarily examines the behavior of stripped bonds through the lens of supply and demand. Stripped bond prices adhere closely to the fundamental requirement of properly discounted future cash flows balancing out today’s market prices.

Neoclassical Economics

Neoclassical economists evaluate stripped bonds by focusing on concepts of arbitrage and market efficiency. The creation of stripped bonds ensures arbitrage opportunities are limited, thus contributing to more efficient markets.

Keynesian Economic

The Keynesian view looks at stripped bonds from the perspective of government policy and aggregate demand. Stripped bonds can influence government debt strategies and interest rates, thereby impacting broader economic activities.

Marxian Economics

From a Marxian standpoint, stripped bonds are an instrument of financial expansion, serving as vehicles for redistributing capital from surplus-seeking entities to profit-maximizing investors. It reflects the intricate division of assets to cater various investment horizons.

Institutional Economics

Institutionalists consider the regulatory environment and the behavior of institutional investors in the market for stripped bonds. Regulations and policies impact the liquidity, demand, and risk profiles associated with these financial instruments.

Behavioral Economics

Behavioral economists might study investor behavior and biases leading to the use and pricing of stripped bonds, assessing psychological aspects influencing decision-making, risk perception, and preference for liquidity and time validity.

Post-Keynesian Economics

Post-Keynesian analyses involve how intrinsic deficiencies or surpluses in aggregate demand influence the utility and market for stripped bonds within economic cycles, emphasizing balance-sheet effects and liquidity preferences.

Austrian Economics

Austrians may explore the role of time preference and capital structure in evaluating strips - considering how separation of bonds into stripped components serve consumer satisfaction and intertemporal planning.

Development Economics

Development theorists can examine how creating financial markets that include instruments like stripped bonds influences economic development through improved capital allocation and risk distribution.

Monetarism

Monetarists focus on the impacts of supply of money and bonds, considering the role of stripped bonds in monetary policy, open market operations, and broader economic equilibrium concerning interest rates.

Comparative Analysis

Stripped bonds distinguish themselves by providing distinct investment outcomes from their underlying traditional bonds. Though sold separately, the synchronized evaluation by investors ensures the pricing mechanisms depict the aggregate value and reduced risks with individual strips.

Case Studies

Studies exploring the introduction of stripped bonds reveal their resilience and adaptability within financial systems, examining diverse global markets’ responses and macroeconomic impacts.

Suggested Books for Further Studies

“Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
“Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
“Modern Portfolio Management: From Markowitz to Probabilistic Scenario Optimisation” by Paolo Sironi

Coupon Bond: A bond that pays periodic interest payments.
Face Value: The nominal value of a bond which is to be repaid to the holder at maturity.
Financial Engineering: The application of mathematical methods to solve problems in finance.
Reinvestment Risk: The risk that future proceeds will have to be reinvested at a lower rate of return.
Principal: The nominal or face amount on which interest is calculated in bond transactions.