A T-note principal strip has six months remaining to maturity. How is its price likely to compare to a 6-month T-bill that has just been issued? It should be: A. lower B. higher C. the same D. set at the coupon rate
They probably want you to say that they are the same because the cash flows are the same. In fact, the on-the-run T-Bill is vastly more liquid so you will probably pay for that.
If it is only the principal strip of the T-note, shouldn’t the PV of it be lower than the PV of the T-bill (that pays no coupons)?
Why do you say that? They are both essentially zero-coupons with a maturity of 6 months
Because T-notes usually have coupon payments just like corporate bonds, unlike the T-bills.
Apparently you are missing the point…PRINCIPLE ONLY strip has no coupons.
Please note it’s not about T-note - instead it says “T-note principal STRIP” which essentially a zero-coupon bond that does not pay periodic interest. Either coupon strip or principal strip, they are traded @ discount-to-par. And T-bill too is traded @discount-to-par. Joey’s answer is correct. I’m just kind of vague of the SAME pricing…
but we are talking about STRIPS (separate trading of registered interest and principal securities), which splits out coupon payments and principal payment into separate securities. “The US Treasury does not issue zero-coupon securities with maturities greater than a year, but it has a program whereby the coupon and principal payments of standard Treasury securities can be disaggregated and traded separately as zero-coupon securities. This is called the STRIPS program, which the Treasury launched in 1985. STRIPS stands for Separate Trading of Registered Interest and Principal of Securities. Under the program, a financial institution can present the Treasury with a standard Treasury note, Treasury bond or TIPS to be “stripped.” The Treasury disaggregates the individual cash flows into separate securities, which are returned to the financial institution. For example, a newly issued 5-year note would be stripped into eleven separate securities—ten representing the note’s semiannual coupon payments, and one representing its final principal payment. The new securities are called coupon strips and principal strips. Collectively, they are called Treasury strips or just strips.”
hyang, other than the liquidity premium you would be getting with the prinicipal strip (as Joey mentioned), what would be different?
You’re all right, the corpus is a zero. The yield on this strip must be at least equal with the yield on the T-bill, or nobody would buy it in the market. I guess that’s why they have the same price.
TheAliMan Wrote: ------------------------------------------------------- > hyang, other than the liquidity premium you would > be getting with the prinicipal strip (as Joey > mentioned), what would be different? The PO strip is reconstitutable with one CI strip back into the original bond, so if there is something funky about that bond it could impact the price (unlikely with 6 months left). When T-bill futures contracts existed and were deliverable, the T-bill would be deliverable but the PO strip wouldn’t be. Possibly some money market funds could only hold the T-bill (dubious).