What Are STRIPS Bonds? Stripped Treasury Securities Explained

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STRIPS (Separate Trading of Registered Interest and Principal of Securities) are zero-coupon securities created by splitting an eligible U.S. Treasury note or bond into its individual cash flows. Each semiannual interest payment and the final principal repayment becomes a separate security with its own maturity date. Each one is bought at a discount and pays its face value once, on that date, with no payments in between.

How STRIPS work

A conventional Treasury note pays a fixed coupon every six months and returns its principal at maturity. Stripping separates those payments electronically.

The Treasury introduced the STRIPS program in 1985. It does not issue STRIPS directly. A financial institution that holds an eligible note or bond asks for it to be stripped through the commercial book-entry system, which records each payment as a separate security with its own identifier. The pieces fall into two groups:

• Interest strips (C-STRIPS): one for each remaining coupon payment.
• Principal strips (P-STRIPS): one for the face value due at final maturity.

The par amount being stripped must be at least $100, and any amount above that must be a multiple of $100. STRIPS are not sold at Treasury auctions or held in TreasuryDirect accounts. Investors buy and sell them through brokers and banks on the secondary market. The process can also run in reverse. An institution that gathers all the required pieces can reconstitute the original note or bond.

Hypothetical stripping example. Suppose $10,000 face value of a 10-year Treasury note with a 4% coupon is stripped at issue. The note pays $200 every six months, so stripping creates 20 interest strips, each with a $200 face value and a different maturity from six months to ten years, plus one $10,000 principal strip maturing in ten years. Any one of those 21 securities can be sold to a different buyer.

How STRIPS are priced

Because a strip is a single future payment, its price is simply the present value of that payment. Using the semiannual convention for Treasuries:

Price = Face value ÷ (1 + y/2)^(2n)

where y is the annual yield and n is the number of years to maturity. That yield is the strip’s yield to maturity, and for a zero-coupon security it is locked in at purchase if the strip is held to the end.

Hypothetical pricing example. Take a strip with a $1,000 face value maturing in 10 years, priced to yield 4%:

Price = 1,000 ÷ (1.02)^20 = about $672.97

An investor who pays $672.97 and holds to maturity receives $1,000, a gain of $327.03. If market yields for that maturity rise to 5% right after purchase, the price becomes 1,000 ÷ (1.025)^20 = about $610.27, a drop of roughly 9.3%. A coupon-paying note with the same maturity would usually fall less, because part of its value arrives earlier as coupons.

How STRIPS are used

The main use is matching a known future expense, such as retirement income in a given year or tuition due in a particular semester, with a strip maturing close to that date that pays an exact dollar amount.

Because each coupon becomes its own security, STRIPS come in a wide range of maturities. Pension funds and insurers use them to fund liabilities due on specific dates. Some investors build a “ladder” of strips maturing in successive years to create a predictable payment schedule from assets that individually pay nothing until maturity.

STRIPS also remove reinvestment risk. A coupon bond’s realized return depends on the rates available when each coupon is reinvested. A strip held to maturity has no coupons to reinvest.

Limitations

• Price volatility. A zero-coupon security’s duration equals its maturity, so long-dated STRIPS can swing sharply when rates move. Treasury backing protects against default, not against losses from selling before maturity.
• Phantom income. In a taxable U.S. account, the discount accretes as original issue discount and is generally reported as interest income every year, even though cash arrives only at maturity. Many investors hold STRIPS in tax-advantaged accounts for that reason. As Treasury obligations, they are generally exempt from state and local income tax.
• Inflation. A strip from a nominal Treasury pays a fixed dollar amount. Over a long horizon, inflation can substantially reduce what that payment buys.

What STRIPS are often confused with

Other zero-coupon bonds. Corporations and municipalities can issue zero-coupon bonds directly. STRIPS differ in how they are made: they are carved out of existing Treasury notes and bonds, and they carry the Treasury’s credit backing.

Treasury bills. T-bills are also sold at a discount and pay face value at maturity, but they are issued directly by the Treasury with maturities of one year or less. STRIPS can run up to 30 years, as long as the security they were stripped from.

The options “strip.” In options trading, a strip is a bearish-leaning strategy that buys two puts and one call on the same stock, with the same strike price and expiration. It shares only the name with Treasury STRIPS.

FAQs

The Bottom Line

STRIPS suit investors and institutions that need a set dollar amount on a known date, such as tuition, retirement income, or pension liabilities. Held to maturity, a strip locks in its yield and removes reinvestment risk, with Treasury backing against default. Holding them in tax-advantaged accounts avoids phantom income, while investors who may sell early or worry about inflation should weigh the sharp price swings and fixed nominal payout.