Value or Yield of an Interest-Only Strip
Thursday, 14 May 2009 10:15

An Interest-Only Strip, or Interest-Only Security, is a bond with a maturity date but on the maturity date it does not pay out the nominal value. Such an instrument is created when a bond is splitted into a zero-coupon bond and an Interest-Only Strip. A zero-coupon bond does not pay any interest but it does pay the nominal value on the maturity date.

Suppose there is an Interest-Only paying \$ 40 once a year. The last payment is on January 1, 2020. Your desired annual yield is 3%. By entering the data below into the calculator you can compute the value of this Interest-Only Strip on May 7, 2009:

FieldValueRemark
Nominal interest4Combined with the Nominal Value of 1000 this tells the calculator that the bond pays a yearly coupon of \$ 40.
Coupon period12 months
Date computation2009-05-07Date format is YYYY-MM-dd.
Maturity date2020-01-01
Interest in advance or afterwardsafterwardsThis is the usual.
Nominal value1000Combined with the Nominal Interest of 4% this tells the calculator that the bond pays a yearly coupon of \$ 40.
Compute Yield to Maturity or ValueValue
Yield5

The result will appear in the field Present value coupons.

The bond calculator can not compute the yield of an Interest-Only Strip with 100% accuracy. However it is usually possible to produce a very good estimate. In the example above suppose the market value is \$ 337. Enter the following date into the bond calculator to compute an approximation of the yield.

FieldValueRemark
Nominal interest4000Combined with the Nominal Value of \$ 1 this tells the calculator that the bond pays a yearly coupon of \$ 40.
Coupon period12 months
Date computation2009-05-07Date format is YYY-MM-dd.
Maturity date2020-01-01
Interest in advance or afterwardsafterwardsThis is the usual.
Nominal value1Combined with the Nominal Interest of 4000% this tells the calculator that this instrument pays \$ 40 each year. The higher the value in this field the worse the approximation of the yield.
Compute Yield to Maturity or ValueYield
Yield5
Market value337
Add coupon to market valueChecked

The result in field Yield is more accurate the smaller the difference between field Present value coupons and field Market value.