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Smart Bond Investing
The U.S. Treasury STRIPS program was introduced in the mid-1980s. STRIPS is the acronym for Separate Trading of Registered Interest and Principal of Securities. The STRIPS program lets investors hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities. While "stripping" also happens to non-U.S. Treasury securities, this discussion applies to stripped U.S. Treasury securities.
When a U.S. Treasury fixed-principal note or bond or a Treasury inflation-protected security (TIPS) is stripped, each interest payment and the principal payment becomes a separate zero-coupon security. Each component has its own identifying number and can be held or traded separately. For example, a 10-year Treasury note consists of 20 interest payments—one every six months for 10 years—and a principal payment payable at maturity. When this security is "stripped," each of the 20 interest payments and the principal payment become separate STRIPS, and can be held and transferred separately. STRIPS can only be bought and sold through a financial institution or brokerage firm (not through TreasuryDirect), and held in the commercial book-entry system.
Like all zero-coupon bonds, STRIPS sell at a discount because there are no interest payments. Your income on a STRIP that is held to maturity is the difference between the purchase price and the amount received at maturity. When you buy a STRIP, the only time you receive an interest payment is when your STRIP matures.
Risk-adverse investors who want to receive a known interest payment at some specific date in the future favor STRIPS. State lotteries and pension funds regularly invest in STRIPS to be assured they will be able to meet annual payout obligations to prizewinners or pensioners.
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