Zero-Coupon Bonds

Investors are urging the Reserve Bank of India (RBI) to permit state government debt to be issued as zero-coupon bonds.

About Zero Coupon Bonds

• Zero-coupon bonds are financial instruments that do not pay periodic interest but are sold at a discount and redeemed at their full face value upon maturity. 
• Benefits of Zero-Coupon Bonds:
  • Simplified interest management since no periodic payments are required.
  • Attractive for investors seeking fixed returns over a specific period.
• Risks involved with Investing in Zero Coupon Bonds: 
  • They do not provide periodic interest payments.
  • The value of these bonds is inversely related to the interest rates. 
  • The longer a bond’s duration, the greater its sensitivity to interest rate changes. 
• State Government Borrowing Context:
  • State Development Loans (SDLs) are currently auctioned by RBI as part of managing state public debt. Issuance as zero-coupon bonds could reduce immediate financial pressures on states​.
• Regulatory Changes and Concerns:
  • Implementation would require adjustments in RBI’s current frameworks for government securities, as valuation and risk parameters for zero-coupon instruments differ from those of interest-bearing bonds​.

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STRIPS Facility

• STRIPS (Separate Trading of Registered Interest and Principal of Securities) allow the splitting of a bond into its principal and interest components.
• Mechanism:
  • A 10-year bond with annual interest can be split into 10 interest payments (coupons) and one principal payment.
  • These components are traded separately in the secondary market as zero-coupon securities.
• Benefits:
  • Enhances liquidity and trading options.
  • Attracts investors with varying maturity needs.
• In India: The STRIPS facility is available for government securities but is underutilized due to limited awareness and technical challenges.