Interest Only Strip

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Interest Only Strip

A derivative security whose cash flow derives exclusively from interest payments on various debt securities. That is, the underlying asset of an interest-only strip is interest paid on debt securities, rather than the debt securities themselves. Many interest only strips are backed by mortgage interest, but some are also backed by Treasury securities and other debt securities. Interest-only strips are derived from bonds whose coupons are legally separated, or "stripped", from the bonds themselves.
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Sale of an IO strip and retention of the PO portion is an obvious example.
After discussions with investors in both assets, I concluded that servicers must replace runoff to utilize their excess capacity (or exit the industry), whereas IO strip investors can stop investing any time they want.
This excess interest (or spread) is economically the same as an IO strip.
IO strips are precisely the same instrument as excess servicing.