Investors who want to invest in a sovereign-backed instrument which offers better returns than fixed deposits, may consider a product called G-Sec STRIPS.
- STRIPS (Separate Trading of Registered Interest and Principal Securities) are created by separating a standard coupon-bearing bond into its individual coupon and principal components.
- Created from G-Secs, both G-Secs (government securities) and G-Sec STRIPS are issued by the Reserve Bank of India (RBI) and have sovereign backing.
- G-Secs pay investors a half-yearly coupon. An investor who invests in, say, a five-year G-Sec (coupon rate, say, 7 per cent) receives 10 coupons, and the principal at the end of five years.
- These coupons and principal can be stripped into separate securities to create G-Sec STRIPS. Each of these STRIPS will pay 3.5 per cent (in this example) on maturity date, and one will pay Rs.100 at the end of five years.
- The RBI auctions G-Secs.
- An entity, such as a primary dealer or a bank, that possesses G-Secs can request the central bank to convert them into G-Sec STRIPS.
- G-Sec Strips allow investors to lock in returns over a wide variety of tenures. One can make these instruments available for tenures ranging from six months to 30-35 years.
- Investors who need a guaranteed payout after a fixed tenure for goals such as a child’s college education or marriage or their own retirement can invest in them.
- Investing in G-Secs wouldn’t work as they don’t need regular payouts.
- Being government-backed, they carry zero default risk. And by holding them till maturity, the investor can eliminate interest-rate risk. Stripping converts each payout into a tradeable instrument.
- Being zero-coupon bonds, STRIPS hos zero reinvestment risk that make the investment attractive to retail investors.
(Sources: ET and BS)
