{ "id": "c53fc391-0919-5e63-9217-78cdeb8a043c", "slug": "strips", "term": "STRIPS", "aliases": [], "category": "Fixed Income", "category_slug": "fixed-income", "difficulty": "intermediate", "definition": "STRIPS (Separate Trading of Registered Interest and Principal Securities) are zero-coupon bonds created by the US Treasury by separating the individual coupon payments and principal of eligible Treasury notes and bonds, allowing each cash flow to be traded independently as a distinct security. Each STRIPS pays a single lump sum at maturity and is priced at a deep discount to that face value.", "key_takeaways": [ "STRIPS are zero-coupon bonds backed by the full faith and credit of the US government, eliminating default risk while providing precise duration exposure.", "The duration of a STRIPS equals its maturity, making it the longest-duration instrument of any given maturity and highly sensitive to interest rate changes.", "STRIPS are created through the Treasury's STRIPS program, which authorizes primary dealers and certain financial institutions to separate Treasury coupons and principal from eligible securities.", "Investors in STRIPS must pay annual income tax on the imputed interest (original issue discount) accreted each year, even though no cash is received until maturity.", "STRIPS are widely used by pension funds and insurance companies to match long-duration liabilities with a single, reinvestment-risk-free cash flow." ], "detailed_explanation": "STRIPS were introduced by the US Treasury in 1985 in response to a private-sector innovation. During the early 1980s, investment banks had begun creating synthetic zero-coupon Treasury products—with creative acronyms like TIGRs (Treasury Investment Growth Receipts) and CATS (Certificates of Accrual on Treasury Securities)—by placing Treasury securities in trust and issuing receipts against individual cash flows. The official STRIPS program standardized and improved upon these products by allowing direct separation of Treasury cash flows within the Federal Reserve's book-entry system, eliminating the counterparty risk inherent in the private custodial arrangements.\n\nThe mechanics of STRIPS creation begin with a strippable Treasury security—a Treasury note, bond, or TIPS that has been designated as eligible for stripping. An authorized participant (typically a primary dealer) presents the whole bond to the Federal Reserve, which disaggregates it into separate book-entry securities: one for each semi-annual coupon payment (designated as 'C-STRIPS' or coupon STRIPS) and one for the principal repayment ('P-STRIPS' or principal STRIPS). Each component carries its own CUSIP number and trades independently. Reconstitution—the reassembly of coupon and principal STRIPS into the original whole Treasury bond—is also permitted and used by arbitrageurs when the yield of the reconstituted whole bond differs from the aggregated yield of its component STRIPS.\n\nFrom a portfolio construction standpoint, STRIPS are unique in their duration properties. A 30-year STRIPS has a modified duration of approximately 29 years—far exceeding the duration of a 30-year coupon Treasury bond (which might have a duration of only 17–18 years). This extreme duration sensitivity makes STRIPS powerful instruments for liability-driven investing (LDI) applications, where pension funds and insurance companies seek to match the duration of their long-dated liabilities precisely without bearing reinvestment risk. By holding STRIPS that mature on the exact dates of projected benefit payments, an LDI manager can immunize the portfolio against parallel interest rate shifts with extraordinary precision.\n\nA critical tax consideration affects the economics of STRIPS for US taxable investors. Under the original issue discount (OID) rules, the annual accretion of a STRIPS bond toward its face value is treated as taxable interest income, even though no cash is received. This phantom income creates a negative cash flow tax liability each year, making STRIPS held in taxable accounts less efficient than coupon Treasuries for after-tax return. As a result, most STRIPS are held in tax-advantaged accounts (IRAs, pension plans) or by tax-exempt entities (pension funds, sovereign wealth funds), which can capture the full pre-tax yield without the OID drag.\n\nIn the market microstructure of STRIPS, liquidity varies significantly between C-STRIPS and P-STRIPS. C-STRIPS maturing on the same date—regardless of which original Treasury note or bond they were stripped from—are fungible and traded interchangeably in the secondary market, creating a deep, liquid pool for each coupon date. P-STRIPS, in contrast, are not fungible (each is tied to a specific bond) and tend to be less liquid. When the Treasury reopens STRIPS-eligible bonds, it increases the supply of fungible C-STRIPS on the corresponding coupon dates, improving liquidity.", "example": "A pension fund has a $10 million liability maturing in exactly 20 years. To immunize this liability, the fund purchases 20-year P-STRIPS with a face value of $10 million. If the current 20-year STRIPS yield is 4.5%, the fund pays $10,000,000 / (1.045)^20 = $10,000,000 / 2.412 ≈ $4,147,000 today. At maturity, the fund receives exactly $10 million regardless of intervening interest rate movements—there is no reinvestment risk because there are no intermediate cash flows. This represents a perfect immunization of the single liability, achieved at a cost of approximately $4.15 million today at current STRIPS yields.", "formula": "STRIPS Price = Face Value / (1 + y/2)^(2T)", "formula_latex": null, "interactive_type": "calculator", "calculator_id": null, "related_terms": [ "bankers-acceptance", "bond", "callable-bond", "collateralized-debt-obligation", "counterparty-risk", "duration", "face-value", "fallen-angel", "interest-rate", "key-rate-duration", "liquidity", "modified-duration", "reinvestment-risk", "treasury-bond", "treasury-note" ], "backlinks": [ "accrued-interest", "mob-spread", "zero-coupon-bond" ], "cross_references": [ "bond", "counterparty-risk", "duration", "face-value", "interest-rate", "liquidity", "modified-duration", "reinvestment-risk", "treasury-bond", "treasury-note", "yield" ], "tags": [ "level:intermediate", "cat:fixed-income" ], "asset_classes": [ "fixed-income" ], "regulators": [], "see_also": [], "sources": [], "wordcount": 821, "checksum": "1e43a42081498399", "version": "2026.05.03", "license": "CC-BY-4.0", "updated_at": "2026-09-07T02:15:24+00:00", "_links": { "self": "https://hedgefund.wiki/api/v1/terms/strips", "jsonld": "https://hedgefund.wiki/api/v1/terms/strips?format=jsonld", "markdown": "https://hedgefund.wiki/api/v1/terms/strips?format=md", "graph": "https://hedgefund.wiki/api/v1/graph/strips", "category": "https://hedgefund.wiki/api/v1/categories/fixed-income", "schema": "https://hedgefund.wiki/schema/term.schema.json", "html": "https://hedgefund.wiki/#/terms/strips" } }