Treasury STRIPS and Receipts Question

I am having trouble understanding the concept of a Treasury Receipt. So I understand a Broker Dealer buys Treasury securities and puts them in a trust and then separates the coupon payment and principal. The trust is then held as collateral for the security that is created. I am confused as to what is an investor buying? Is an investor buying the coupon payment? Is the investor also buying the principal as a zero coupon security? If so, why not just buy the Treasury security in the first place? Why the separation of the principal and coupon?

Can someone walk me through an example and explain?

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Comments (2)

Most Helpful
Jul 11, 2019

the US govt borrows money in the form of bonds....that have a principal payment at maturity and a series of coupon payments during the life of the bond,

So, imagine the govt borrows $10,000,000,000 (10 bln) at a 6% annual interest rate, paid semi-annually (3%, twice a year). Back in the 1980s, Japanese investors wanted to buy just the 30 yr principal payment...a zero coupon bond. But the US govt doesn't borrow in the form of zero coupon bonds (well, they do in the short term under 1 year, and call those treasury bills...but forget that) we are talking about 30 year bonds.

So, how can the Japanese (or US insurance companies) buy a zero coupon 30yr bond? Originally....they couldn't. But them Lehman, ML ad Solly came up with the idea of putting the 30yr coupon bonds into a trust, and then selling the individual coupon and principal cashflows. These were CATS (Solly) TIGRS (ML) and Lions (Lehman).

Then, in 1986 the Treasury and US Federal Reserve created the STRIPS program, where a primary dealer could deliver a bond to the Fed, and the Fed would return zero coupon bonds representing each of the cash flows (coupons and principal).

These coupons and Principals each have their own cusip, and are tradable securities.

So, now an investor can buy ANY of the cash flows that they want. They could buy just the principal payment, which matures on the maturty date...or they could buy one of the coupons, which matures on the coupon payment date (in a 30yr bond, there are 60 coupons..paid semi-annually).

These zero coupon securities have no other cashflows...hence "zero coupon"

So, the question now much is a zero coupon bond worth? and the answer lies in the interest rate. What would an investor be willing to pay for $100 in 30 years? The exact answer depends on the prevailing level of interest rates...but right now its around $45.

When rates were higher, 30yr zeros traded around $30 (so, 30yr zero coupon security prices are very sensitive to interest rates).

Why buy a 30 year zero coupon security? Some asset managers, like insurance companies and pension funds can estimate their long term liabilities...and then buy a portfolio of zero coupon securities to exactly match up with their long term liabilities. These asset managers are the primary buyers of zero coupon bonds. However, there is a secondary trading market..and so hedge funds will try to arb any kinks in the yield curve. This was popular before the 2008 financial crisis...but less so these days.

just google're welcome

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Jul 11, 2019