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Treasury "STRIPS," or Separate Trading of Registered Interest and Principal Securities, are investments that a bank or brokerage firm creates by restructuring the payment obligation of certain types of securities. To create Treasury STRIPS, a firm takes a specific type of security, breaks it apart into separate components, and sells each component to investors. Breaking the security apart is called stripping, and each component becomes a separate security instrument. The term security instrument is a broad term that describes stocks, bonds, and many other investment vehicles.
A brokerage firm can only restructure certain types of securities into Treasury STRIPS. For example, an investment bank purchases securities such as Treasury Notes, also known as T-Notes. A T-Note pays its holder a certain interest rate every six months. It also contains a maturity date that may be from one year to 10 years, which means that the holder of the T-Note may cash it in at the maturity date and receive a principal payment of a specified amount. Hence, the holder of a 10-year T-Note would receive 20 interest payments plus a principal payment when the T-Note reaches maturity.
If a brokerage firm wants to create Treasury STRIPS, it can take the 10-year T-Note and restructure it into separate securities. This means that each six-month interest payment obligation would become a distinct security instrument. The principal payment obligation when the T-Note reaches maturity would also become a separate security instrument. The firm could then sell each instrument from the 10-year T-Note as Treasury STRIPS to different investors. Companies that create Treasury STRIPS sell each newly created security instrument as a zero-coupon bond to investors.
Bankers use the term zero-coupon bonds for Treasury STRIPS because the bonds pay no interest to the holder. Instead, this kind of bond pays a specified amount when it reaches its maturity date. Zero-coupon bonds provide various maturity dates for investors. For instance, an investor may choose to purchase zero-coupon bonds that only mature at six months, at 30 years, or at any other period in between.
In addition to T-Notes, a broker can create Treasury STRIPS from Treasury bonds and Treasury Inflation Protected Securities (TIPS). Treasury bonds or T-Bonds are similar to T-Notes except that the maturity dates run from 20 to 30 years. TIPS have maturity dates of five, 10, or 30 years. The U.S. Treasury issues T-Notes, T-Bonds, and TIPS. It, however, does not issue Treasury STRIPS.
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