Treasury Strips

Treasury strips are synthetically created zero-coupon securities. They are further classified as coupon strips and principle strips. What is the difference between these two sub-classes and what is the purpose to strip the coupon bearing Treasury security? And from the investors’ point of view, what are the major advantages to invest in these strips than in the on-the-run coupon bearing T-securities?

I thought the curriculum went through why stripping would be useful. Once instance is when the constituents are worth more than the security as a whole (or vice versa). This offers an arbitrage opportunity for those who recognize the situation. Another is when an investor doesn’t want to face reinvestment risk (zeros have none), but also wants the characteristics of a Treasury bond (“no” credit risk). This is important because the Treasury doesn’t offer zeros w/ long maturies, so the market has to create them.

I don’t think there is much difference between the two classes of STRIPS except that if you reconstitute the bond (legal and acceptable) you can’t substitute principal for interest or vice versa. You can substitute a CI from one bond for another. Edit: Seems to me that someone on AF suggested that outside the US there is a tax difference. I don’t know about that…

ymmt Wrote: ------------------------------------------------------- > I thought the curriculum went through why > stripping would be useful. Once instance is when > the constituents are worth more than the security > as a whole (or vice versa). This offers an > arbitrage opportunity for those who recognize the > situation. Another is when an investor doesn’t > want to face reinvestment risk (zeros have none), > but also wants the characteristics of a Treasury > bond (“no” credit risk). This is important because > the Treasury doesn’t offer zeros w/ long maturies, > so the market has to create them. Good answer ymmt. My thoughts exactly.

you strip to determine whenther or not there is arbitrage. if the strips vlaues tally up to MORE than the value of the bond when it is not stripped, you can break up the bond and sell the pieces. this is hard to do, but it is a key tenet of modern finance – the no arbitrage rule

It’s not at all hard to strip the bond - that’s the purpose of the STRIPS program. You do it electronically and it’s very routine. Easier and faster than downloading “Fight Club” from Amazon.

So no particular advantage of principle strips over coupon strips or vice versa. But the disadvantage is just like any other zero-coupon bond, you’ve got to pay tax for the interests even though you won’t get it till maturity. Yes, it does mention foreign investors may have a preference for principle strips because the interests would be taxed as capital gain rather as ordinary income. So should American investors, right? Also it mentioned T strips are created by private sectors although they are direct US gov obligations. Wondering why bother the private sectors?

JoeyDVivre Wrote: ------------------------------------------------------- > It’s not at all hard to strip the bond - that’s > the purpose of the STRIPS program. you misunderstood me dude. i meant it is hard to find arbitrage situations : ) -