Treasury STRIPS
Also known as: STRIPS, separate trading of registered interest and principal of securities
Treasury STRIPS are zero-coupon securities created by separating the interest and principal payments of Treasury notes and bonds. They are bought at a discount and pay no interest until they mature at face value.
Treasury STRIPS — short for Separate Trading of Registered Interest and Principal of Securities — are zero-coupon investments carved out of ordinary Treasury notes and bonds. Financial institutions "strip" each coupon payment and the principal repayment from a Treasury security and sell each piece as its own security. Every piece is purchased at a discount and pays a single lump sum at maturity.
For example, an investor might pay roughly $750 today for a STRIP that pays $1,000 in ten years. The $250 difference is the investor's return, earned entirely through the security's gradual accretion toward face value rather than through semiannual interest checks. Because STRIPS are derived from Treasury securities, they carry the full faith and credit of the U.S. government.
STRIPS have two defining trade-offs. On the plus side, they eliminate reinvestment risk — there are no coupon payments to reinvest at uncertain future rates, making them popular for funding a known future goal like college tuition or retirement. On the minus side, they are highly sensitive to interest rate changes, and holders owe federal tax each year on the accreted ("phantom") income even though no cash is received until maturity. Treasury receipts are a similar broker-created product from before the STRIPS program; unlike STRIPS, receipts are backed by the underlying collateral held in trust rather than directly by the U.S. government.
The Series 7 exam tests STRIPS and Treasury receipts within its U.S. government debt material. Know how they are created, why they avoid reinvestment risk, the phantom income tax treatment, and the backing difference between STRIPS and receipts.
Key takeaways
- STRIPS are zero-coupon securities created by separating the coupons and principal of Treasury notes and bonds.
- Investors buy them at a discount and receive face value at maturity, with no interim interest payments.
- STRIPS eliminate reinvestment risk but are highly sensitive to interest rate changes.
- Accreted growth is taxed annually as phantom income even though no cash is paid until maturity.
- STRIPS are directly backed by the U.S. government; older broker-created Treasury receipts are not.