Definition
Treasury Strips are a form of U.S. government debt in which individual principal and interest payments can be separately traded. Each individual payment is treated as a zero-coupon bond, which pays no interest until maturity. Treasury Strips is an acronym for “Separate Trading of Registered Interest and Principal Securities.”
Key Takeaways
- Treasury Strips are a form of U.S. government debt securities that are sold at a discount from face value and offer no interest payments because they mature at par. This means they are essentially zero-coupon bonds.
- Strips stands for Separate Trading of Registered Interest and Principal of Securities. The concept was introduced by the U.S. Treasury Department in 1985 to enable the separate trading of the principal and interest components of eligible Treasury securities.
- Investors often consider treasury strips as risk-free investments since they are backed by the U.S. government, but they are still subject to interest rate risk, which can influence their price significantly particularly over a long term.
Importance
Treasury Strips, which stands for Separate Trading of Registered Interest and Principal of Securities, are an important financial tool because they offer a low-risk investment option for investors. They help investors manage their risk exposure while providing steady, predictable income streams.
Strips are parts of treasury bonds or notes sold separately, with each part typically representing either the principal repayment or the interest payment on these instruments. This form of investment allows investors to match their future cash liabilities without the risk of reinvestment, since STRIPS pay no coupons and are redeemed at par value at maturity.
Also, Strips are backed by the U.S. government, making them attractive for risk-averse investors, and they can be held in tax-deferred retirement accounts, which can be beneficial for tax planning strategies.
Explanation
Treasury Strips, an acronym derived from Separate Trading of Registered Interest and Principal Securities, are a type of U.S. government security issued by the federal government. Its purpose is to cater to the unique investment needs of some investors who don’t want periodic interest payments but are interested in a guaranteed return at a specific point of time.
Essentially, they are zero-coupon securities that offer investors the option of owning fixed income securities without having to worry about reinvestment risk. Treasury Strips are typically used by individuals who are looking to establish a predictable income stream for a specific future year, such as retirement or a child’s education. Since Treasury Strips are purchased at a significant discount to face value, they provide a guaranteed return without any reinvestment risk.
As they stem from a highly creditworthy issuer (the U.S. government), they are considered risk-free investments. While the discount purchasing shields investors from interest-rate fluctuations, the absence of semi-annual interest payments also shapes Treasury Strips as an ideal investment for those who don’t require periodic income, e.g., retirement and pension funds.
The definitive maturity dates further add to their popularity among long-term investors who have a specific financial objective in a particular future timeframe.
Examples of Treasury Strips
Retirement Investment: An individual looking to secure their retirement might purchase U.S. Treasury STRIPS. Since they do not pay interest until they mature, they are less likely to negatively fluctuate in value. This stable and predictable investment could contribute to the individual’s retirement fund that they will access years later.
Corporate Investment: A corporation with surplus cash might invest in Treasury STRIPS in order to hedge against inflation. As these are government-backed securities, they offer a low-risk investment opportunity. Over time, this will serve to protect the corporation’s cash reserves and also appreciate in value.
Education Savings Plan: A parent might buy Treasury STRIPS to contribute towards a college savings plan for their child. They could buy the STRIPS so that they mature right around the time the child is expected to start university. This allows the parent to make an upfront investment with the guarantee of a future payout.
Treasury Strips FAQ
What are Treasury Strips?
Treasury Strips are fixed-income securities sold by the U.S. Treasury. They are called “Strips” because the securities are “stripped” or subdivided into separate securities representing the individual principal and interest payments.
How are Treasury Strips created?
Treasury Strips are created through a process known as “coupon stripping” where the interest coupons are separated from the principal amount and each sold as standalone securities. This process is done by brokers and dealers, not individual investors.
Who can purchase Treasury Strips?
Any individual or institutional investor can purchase Treasury Strips. They can be bought and sold through financial institutions and government securities brokers and dealers.
What are the benefits of investing in Treasury Strips?
Treasury Strips offer a reliable and risk-free investment because they are backed by the U.S. government. They are ideal for investors who want a guaranteed income at a future date because they are sold at a discount, but at maturity, they pay the full face value.
What is the risk associated with Treasury Strips?
The biggest risk with Treasury Strips is their sensitivity to interest rate changes. Since they do not pay periodic interest, all of its return is subject to price appreciation or depreciation, making them highly sensitive to interest rate fluctuations.
Related Entrepreneurship Terms
- Principal Strips
- Interest Strips
- Zero-Coupon Bonds
- Government Issued Securities
- Fixed Income Securities
Sources for More Information
- TreasuryDirect: This official U.S. government site allows you to buy and redeem securities directly from the U.S. Department of the Treasury in paperless electronic form.
- Investopedia: A comprehensive online resource for understanding finance and investing terminology and strategies, including terms like Treasury Strips.
- MarketWatch: Provides real-time financial market coverage and business news, including articles explaining Treasury Strips.
- Bloomberg: Known for being a leading resource for financial, economic and investment information, including Treasury Strips and how they work.
