Legal Definitions - separate trading of registered interest and principal of securities

STRIP stands for Separate Trading of Registered Interest and Principal of Securities. It refers to a U.S. Treasury security where the individual interest payments and the final principal payment of a bond are separated and sold as distinct, zero-coupon securities. This allows investors to purchase either the principal component or one of the interest components, rather than the entire bond.

STRIPS stands for Separate Trading of Registered Interest and Principal of Securities.

This term refers to a type of U.S. Treasury security where the individual interest payments (known as "coupons") and the final principal payment of a bond are separated from each other and sold as distinct, individual securities. Instead of buying a complete bond that pays regular interest and returns the principal at maturity, an investor can purchase only the right to receive a specific future interest payment, or only the right to receive the bond's principal amount when it matures. Each of these separated components then trades independently in the market.

• Example 1: Planning for a Future Lump Sum

  Imagine a couple saving for their child's college education, which they anticipate needing in 15 years. Instead of buying a regular 15-year Treasury bond, they could purchase a principal STRIP from an existing 30-year Treasury bond that matures exactly 15 years from now. They buy this STRIP at a discount today and, in 15 years, they receive the full face value of the principal, providing the lump sum needed for tuition.

  How this illustrates the term: The couple specifically bought only the principal component of a longer-term bond, separating it from all the interest payments that the original bond would have made. They are not receiving any periodic interest; they are solely focused on the future principal payment.

• Example 2: Creating a Future Income Stream

  Consider a retiree who wants to ensure a steady income stream starting five years from now, perhaps to supplement their pension. They could purchase a series of interest STRIPS from various long-term Treasury bonds, choosing those that mature monthly or quarterly starting in five years. For instance, they might buy the interest payment due in January five years from now, then the one due in February, and so on.

  How this illustrates the term: This investor is acquiring only the rights to specific future interest payments, effectively creating a customized income stream without ever owning the underlying bond's principal. Each interest payment is traded and held as a separate security.

• Example 3: Institutional Liability Matching

  A large pension fund has a known obligation to pay out a significant sum to its beneficiaries in 20 years. To precisely match this future liability, the fund's managers decide to invest in a principal STRIP from a 20-year Treasury bond. By doing so, they lock in a guaranteed payment that perfectly aligns with their future obligation, minimizing reinvestment risk.

  How this illustrates the term: The pension fund is not interested in the periodic interest payments of a full bond; their sole objective is to receive the principal amount at a specific future date. They have separated the principal component and are trading it independently to meet a precise future financial need.