STRIPS Needs A Regulatory Revisit

STRIPS, or zero-coupon securities that afford separate trading of interest and principal, have the potential to grow exponentially because of rising demand and help deepen India’s capital market.

The facility was introduced in 1994 by the Reserve Bank of India as a pilot and saw zero-coupon bonds formally adopted in April 2010. And in June 2025, the central bank also introduced the option to include state government securities (G-secs) in STRIPS.

Stripping entails separating a standard coupon-bearing bond into its individual coupon and principal components. For instance, a five-year coupon bearing G-sec with half-yearly coupon payment can be stripped into 10 coupons and one principal instrument, all of which would then become zero-coupon bonds.

Allowing investors to split G-secs into zero-coupon bonds has helped unlock liquidity and deepened trading in the sovereign market.

The surge in the uptake of STRIPS can be gauged from the fact that a whopping ~Rs 2.47 lakh crore of these bonds were traded in face value terms in fiscal 2025, clocking a compound annual growth rate (CAGR) of ~45% since fiscal 2020. As on November 13, 2025, the total bond outstanding stood at ~Rs 8.8 lakh crore, i.e., ~7.5% of the total G-sec outstanding.

The recent focus on mark-to-market (MTM) pricing of STRIPS presents a timely opportunity to reassess current pricing frameworks, address their challenges and explore ways to enhance their robustness.

Two methods are currently used to determine pricing: trade-based and bootstrapping.

The trade-based method is typically the MTM approach for valuing bonds, where trades are used as input to derive yields/spreads for each traded STRIPS bond over a similar-duration G-sec benchmark. Spreads for non-traded securities are derived using spreads of traded securities.

In contrast, the bootstrapping method is a forward substitution approach that allows investors to determine zero-coupon rates using the par yield curve. The par yields are the yields to maturity on coupon-bearing G-secs over a range of key tenures. The derived zero-coupon yield curve is used to value each STRIPS bond.

Trade-based pricing is an ideal approach, as it reflects the fair price of a security without any external considerations, based solely on the exchange of that specific security.

Bootstrapping, on the other hand, is a scientific but theoretical approach used when a model price is needed in the absence of a relevant market price.

Despite high reported volumes, the trade-based approach faces challenges because of the way traded yields are currently reported, especially at origination. These trades are reported along with secondary trades.

Yields at the longer end of the curve are primarily reported at a single average yield value for operational ease, rather than the ISIN level of each STRIPS bond traded.

For example, on the Negotiated Dealing System (NDS) exchange, STRIPS bonds with maturities ranging from 2036 to 2074 were reported at a single yield of 7.20% on October 23, 2025, and those with maturities from 2039 to 2061 were reported at a single yield of 7.25% on October 10, 2025.

This approach resulted in discrepancy in fair price discovery and an inaccurate representation of the yield curve’s steepness, leading to the widespread use of the bootstrapping method.

It is evident that traded yields should be reported in a way that reflects market dynamics and the tenure of the security, allowing for an observable yield curve to be ascertained.

The bootstrapping approach is crucial when reported prices do not accurately reflect the price discovery of these instruments. It considers two key elements: the duration of the STRIPS bond and the yield of the corresponding G-sec.

To ensure MTM valuations capture the correct pricing, actual ISIN-wise yields instead of a single average yield should be reported for all securities.

Actual ISIN-wise yield and price should be reported for each STRIPS bond, ensuring there is no gap between trade reporting on the NDS and the actual traded levels. As a result, the valuation approach will be closely aligned with fair trade levels.

To achieve this, market regulators, in conjunction with participating institutions, should create a comprehensive price discovery framework that can be employed for trading as well as reporting, thereby enhancing trade transparency and recognition.

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