Separate Trading of Registered Interest and Principal of Securities

Separate Trading of Registered Interest and Principal of Securities

Also called STRIPS, a Treasury security whose coupons have been separated from the principal. STRIPS therefore pay no interest. They are sold at a significant discount from par and mature at par. STRIPS fluctuate in price, sometimes dramatically, because changes in interest rates made them more or less desirable. STRIPS could be invested IRAs and other pension accounts; however, unlike other Treasury securities, they are subject to federal taxes. STRIPS are quoted according to their yields rather than their prices. They began to be issued in 1985, rendering obsolete similar securities, such as CATS, which behaved similarly. See also: zero-coupon bond.

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Separate Trading of Registered Interest and Principal of Securities (STRIPS)

Treasury securities that have had their coupons and principal repayments separated into what effectively become zero-coupon Treasury bonds. The parts, issued in book-entry form, carry the full backing of the U.S. Treasury. Like other zero-coupon bonds, these securities are subject to wide price fluctuations. They also subject the owner to an annual federal income-tax liability even though no direct interest is paid.

Case Study The acronym STRIPS derives from stripping, or peeling, interest payments from Treasury bonds and selling the interest payments and principal amounts as separate zero-coupon securities. Zero-coupon securities were created in the early 1980s when investment firms stripped interest coupons from Treasury bonds and sold interest payments and principal amounts at their current discounted values. These firms acquired large blocks of regular coupon-paying Treasuries that were placed in trust with commercial banks. The banks then issued certificates against each of the interest payments as well as against the principal amount of each bond. Thus, a group of ordinary Treasuries was converted into numerous zero-coupon securities, each with a different maturity. For example, an investment firm might purchase a large number of 15-year Treasury bonds, deposit the bonds with a commercial bank, and the commercial bank would issue a series of zero-coupon securities with maturities ranging from six months (the date of the first interest payment) to 15 years (the date of the last interest payment and the payment of principal). Thus, the 15-year bonds are converted into 30 separate zero-coupon bonds. The new zero-coupon securities became so popular with investors that, in 1985, the U.S. Treasury introduced STRIPS. With these securities, interest and principal payments from U.S. Treasury securities are registered separately through the Federal Reserve. Each interest payment and the principal amount can then be sold to investors as a zero-coupon bond maturing on the date of the scheduled payment.