A stripped bond is a bond that has had its main components split into a series of coupons (interest payments) and a principal repayment (zero-coupon bond). This approach makes it possible to trade the principal repayment and related interest payments separately.
France was the first European sovereign debt issuer to authorise bond stripping in 1991. It has since become the euro area benchmark for stripped bonds.
The market for stripped OATs boasts the same liquidity and security guarantees as those granted to other Government securities. Stripping and unstripping is managed by an economic interest group comprising Euroclear France and primary dealers. This group establishes the rules for dealing in bonds of this kind. AFT acts in an advisory capacity.
Primary dealers act as market makers. OAT bonds are listed on the Euronext Paris exchange and traded on the basis of a discount rate expressed as an annual percentage calculated on the basis of 365 or 366 days (ACT/ACT). The price is rounded up to the fourth decimal place as a percentage of the par value.
The following formula is applied in order to calculate the price to be paid for a Strip:
n = number of full years to maturity
f = number of days between value date and the next 25 October (or April) divided by 365 or 366.
Strips are settled on D + 3 through Euroclear France, Clearstream International or Euroclear.
At the end of 2009, AFT introduced new rules for stripping and unstripping trades on fixed-rate OATs in response to market demand. The new rules introduced an individual bond that makes no distinction between principal and interest: a “fungible zerocoupon bond”. When stripped, OATs are divided into a number of these bonds with the same par value (€0.01) but different maturities, modelled on cash flows attached to the original OAT. All same-maturity bonds are mutually fungible. They may also be unstripped to reconstitute the original bond or a synthetic bond composed of bonds from different OAT issuances. Coupons from different OATs are mutually fungible if they have the same maturity. Like all euro area bonds, zero-coupon bonds issued by AFT after January 1, 2013 have collective action clauses. They are therefore not compatible with bonds issued prior to this date.
Stripped bonds allow, for example, final investors to improve the performance of their bond portfolio because of their greater sensitivity to interest rate movements. This offers them greater leverage than on a conventional OAT. Stripped securities also allow elimination of the interest rate risk linked to reinvestment of the coupons of a conventional security. Moreover, the duration of OAT certificates is longer and these have a more sharply convex curve than on OATs of the same maturity.