It is not surprising, therefore, that the Treasury now sanctions trading in strips. Using the example in Topic 4.
Consider a portfolio of This portfolio provides the following cash flows:. Recall that quoted prices for T - notes on the secondary market do not reflect the accrued interest on the security. The buyer must pay the seller an additional amount to compensate for accrued interest.
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For the current example, we can compute the accrued interest as follows:. Let the face value be standardized at If you engineer the T - note in the strip market from its stripped components, then the prices are:.
Note that the prices between the two markets are strikingly similar, which indicates that, for this issue, there is no arbitrage opportunity. If you assume that no arbitrage opportunity exists between the strip and the other Treasury markets, you should construct the yield curve directly from the strip market.
This is simple and eliminates any problems associated with progressive calculations using T - notes and bonds as well as knowing the precise contractual details for these securities. Decimal Bid. Decimal Ask.
Stripping/reconstitution of bonds made easier - The Hindu BusinessLine
The dealers obviously make a healthy profit on stripping bonds. On the other hand, each strip bond is valued using the YTM of a comparable bond, a 5 year bond for a 5 year coupon and a 30 year bond for the 30 year residual.
The sum of the parts is usually worth more than the whole bond was prior to stripping. Taken individually, each of these payments is an obligation of the issuer, in this case, the Government of Canada.
MEF - Ministero dell'Economia e delle Finanze - Dipartimento del Tesoro
This allows the components to be registered and traded as individual securities. Once a bond has been stripped, a trustee directs the appropriate amount of the interest or maturity payment to the security holders. The holder of a zero coupon receives the par amount of the particular term of the zero that she holds.
If we start on December 1, the first two payments are identical to a 6-month and 1-year T-Bill. The basic math is easy.
What should an investor pay for the 1-year coupon? As a rough cut, forgetting the compounding of interest interest-on-interest and the conversion to semiannual yields, we know that 5. Pulling out our trusty bond calculator, we can actually do the calculation.