Strips - a basic question...

Water Cooler Investing
#1

Hello all,

Just a very quick and basic question on Strips for someone who’s feeling helpful today,

I’ve been told that when a fixed interest security is stripped down it can be done so into all of its interest payment dates and its redemption payment. So a basic example, a five year government bond could be stripped down into 11 seperate securities (10 interest payments strips and the redemption strip).

That I understand fine, what I don’t completely understand is the structure behind them as I was told each strip will also get some of the redemption capital?

Now that would make sense if there were only 10 strips (using the above example) as the redemption amount would be split evenly between them when the time comes but if there’s a redemption strip then surely ALL the capital is redeemed to that particular strip’s holder?

This would also mean the interest payment strips just mature on their set interest payment date?

I hope someone can help with this, it’s only a little issue but its niggling nonetheless!

Thankyou,

#2

I don’t know where you heard that and IO would get any principal component.

#3

Hi Lockheed,

Thanks for your reply,

Ah it was just an article on fixed interest securities that has now confused me,

‘IO would get any principle component’ - surely by definitiion ‘Interest Only’ strips are kept seperate from the principle component?..

#4

There are CMO structures where it is an interest only instrument until the final maturity date, because the underlying notes are balloons. But from what I know, normal IO strip doesn’t have a principal component.

#5

Double Post.

Since I double posted, I guess I should add you’d use “CPY” as the prepayment measure for the above CMO structure. 100% CPY would be the same as 0 CPR until yield maintenace period ends, afterwards it would be 100 CPR.