Stripped Treasuries (STRIPS)

STRIPS (Separate Trading of Registered Interest and Principal of Securities) are zero-coupon bonds created by financial institutions that purchase regular Treasury notes and bonds, then separate the coupons from the principal and sell them individually. A 10-year Treasury note that pays coupons every six months becomes 20 separate zero-coupon instruments: 20 coupon payments (each a mini zero-coupon bond maturing on a coupon date) and 1 principal payment (a 10-year zero). STRIPS are pure discount bonds: you buy them at a deep discount to face value and receive a single payment at maturity with no interim coupons.

Key takeaways

• STRIPS are created by dealers stripping Treasury securities into separate coupon and principal components
• Each stripped component is a zero-coupon bond with a specific maturity date
• STRIPS have very high duration (roughly equal to their maturity) and are extremely price-sensitive to interest-rate changes
• They are ideal for investors with known long-term liabilities (education costs, retirement, pension obligations)
• The lack of interim coupon cash flows makes STRIPS useful for matching liability schedules
• STRIPS are less liquid than whole Treasuries and have wider bid-ask spreads

How STRIPS are created and traded

The STRIPS market operates as follows: a dealer (investment bank) purchases, say, $100 million in 10-year Treasury notes paying 4% coupons. The dealer then applies to the Treasury for permission to strip the security (this is called a "stripping authorization" and is routine for large dealers). Once authorized, the dealer separates the 20 coupon payments ($4,000 each, due on each coupon date) from the principal ($100,000, due in 10 years).

The dealer then sells these 20 coupon strips and the principal strip individually. Each strip is a separate Treasury security with a unique CUSIP (identification code) and maturity date. For example:

• Strip 1: matures in 6 months, receives $2,000 (half of the first coupon)
• Strip 2: matures in 1 year, receives $2,000 (the second coupon payment)
• ...and so on through...
• Strip 20: matures in 10 years, receives $2,000 (final coupon)
• Principal strip: matures in 10 years, receives $100,000

Each of these strips is issued at a discount to its face value. If the market yield on a 10-year instrument is 4%, the principal strip (receiving $100,000 in 10 years) is issued at a price of roughly $67,560. The investor buys for $67,560 and receives $100,000 at maturity—a gain of $32,440.

Duration and interest-rate sensitivity

STRIPS have very high duration—near their maturity in years. A 10-year STRIPS principal has a duration of roughly 10 years, meaning a 1% rise in yields causes the price to fall roughly 10%. A 30-year STRIPS principal has a duration of roughly 30 years, meaning a 1% rise causes the price to fall roughly 30%.

This extreme duration makes STRIPS highly volatile. In 2022, when the Fed raised rates sharply, 30-year STRIPS crashed in value. An investor who bought a 30-year STRIPS at par ($100) for $33 (discounted) saw the price fall to perhaps $21 as yields rose—a 36% loss. But if that investor held to maturity (30 years), they received the full $100.

This volatility is the main reason STRIPS are suitable only for investors with:

• Long time horizons (decades)
• Specific known liabilities (education costs in 15 years, retirement in 20 years)
• The ability to stomach large mark-to-market losses without panicking

STRIPS for liability matching

The primary use case for STRIPS is liability matching. Suppose you know you need $100,000 in 15 years to fund your child's college education. You could buy a 15-year STRIPS principal yielding 4%, costing roughly $56,700. You invest $56,700 today, hold for 15 years, and receive $100,000 at maturity—exactly matching your liability.

This is called a "zero-coupon bond ladder" or "liability matching strategy." It eliminates reinvestment risk (you don't have to worry about reinvesting coupon payments) and interest-rate risk (the return is locked in if you hold to maturity). It's a common strategy for pension funds and endowments with known long-term obligations.

Without STRIPS, you'd have to buy a regular 15-year Treasury note, collect coupons, and reinvest them for 15 years—but you wouldn't know the final value until the end, because reinvestment rates are unknown. STRIPS guarantee the outcome.

Creating a STRIPS ladder

You can construct a STRIPS ladder to match a series of future liabilities. For example:

• Need $50,000 in 5 years: buy $50,000 face value of 5-year STRIPS for ~$40,930
• Need $75,000 in 10 years: buy $75,000 face value of 10-year STRIPS for ~$50,185
• Need $100,000 in 15 years: buy $100,000 face value of 15-year STRIPS for ~$56,700

Total investment: ~$147,815. In 5, 10, and 15 years, you receive the exact cash flows needed, with no market risk or reinvestment risk.

Buying STRIPS directly

STRIPS are not issued directly by the Treasury; they are created and traded by financial institutions. You cannot buy STRIPS at TreasuryDirect. Instead, you buy them through a brokerage (Fidelity, Vanguard, Schwab, Interactive Brokers). The minimum investment is typically $1,000–$5,000 per STRIPS, and bid-ask spreads are wider than for regular Treasuries (perhaps $0.50–$2.00 per $1,000 face value, or 0.05–0.2% of the price).

When you place an order to buy a specific STRIPS, the dealer fills it from their inventory or matches it with a seller. The process is straightforward, but it requires knowing the specific CUSIP of the STRIPS you want. A brokerage's fixed-income desk can help you identify available STRIPS matching your liability schedule.

Phantom income and tax complexity

STRIPS generate "phantom income" or "accrued interest," just as TIPS do. Even though you receive no coupon payments, you owe federal income tax each year on the accrued interest (the annual increase in the bond's value).

For example, a $50,000 face-value 5-year STRIPS purchased for $40,930 will accrue roughly $1,800 in value per year (not exactly, due to the power of the discount formula, but this is the rough math). You owe federal income tax on this $1,800 even though you receive no cash. At maturity, you receive $50,000, of which $9,070 is taxable gain.

This tax complexity makes STRIPS more attractive in tax-deferred accounts (401(k), IRA, Roth IRA). In a traditional IRA or 401(k), you owe no tax until withdrawal. In a Roth IRA, you owe no tax at all. In taxable accounts, the annual phantom income is annoying, though you can harvest losses to offset gains in other parts of your portfolio.

Real yields on STRIPS and inflation risk

STRIPS offer a locked-in real return only if you hold them to maturity. A 10-year STRIPS yielding 3.5% will deliver 3.5% nominal return regardless of inflation, but your real return depends on inflation during those 10 years. If inflation averages 2%, your real return is 1.5%. If inflation averages 4%, your real return is -0.5%.

STRIPS thus offer a locked-in nominal return but leave inflation risk unhedged. This is the opposite of TIPS, which lock in a real return but leave inflation risk transferred to the issuer. Investors can combine STRIPS and TIPS for a fully hedged approach: use TIPS to fund liabilities with inflation risk, use STRIPS to fund liabilities with known real values.

Comparison with regular Treasury bonds and TIPS

Why use STRIPS instead of a regular bond? Consider three approaches to funding a $100,000 liability in 15 years:

1. Regular Treasury note: Buy a $100,000 face-value 15-year note yielding 4%, costing ~$77,000. Collect coupons for 15 years and reinvest. At maturity, receive $100,000 plus reinvested coupons. The final value depends on reinvestment rates—unknown today.

2. STRIPS: Buy $100,000 face-value 15-year STRIPS, costing ~$56,700. Hold for 15 years. At maturity, receive $100,000. The final value is known today.

3. TIPS: Buy $100,000 face-value 15-year TIPS, costing ~$68,000 (assuming 2% real yield). Collect coupons on the inflation-adjusted principal. At maturity, receive $100,000 × inflation adjustment + accumulated coupons. The final real value is known, but the nominal value depends on inflation.

Each approach has merit:

• Use STRIPS to lock in a nominal outcome with no reinvestment risk
• Use TIPS to lock in a real outcome with inflation protection
• Use regular notes if you're comfortable with reinvestment risk and inflation risk

STRIPS market depth and liquidity

STRIPS are less liquid than whole Treasuries. A dealer might maintain a broad inventory of common maturities (5-, 10-, 20-, and 30-year STRIPS) but not every coupon strip or unusual maturity. If you want to sell a STRIPS before maturity, you may face wider spreads or difficulty executing a large order. For buy-and-hold investors, this is irrelevant; for traders, it matters.

The secondary STRIPS market quotes bid-ask spreads in the range of $0.50–$2.00 per $1,000 face value, or 0.05–0.2%, significantly wider than for regular Treasuries (which trade at $0.125–$0.25 per $1,000). Over a 10-year holding period, this spread is negligible; for a quick trade, it's a meaningful cost.

Building a college funding plan with STRIPS

Here's a practical example: You have a 5-year-old child and want to fund their college education (ages 18–22, in 13–17 years). Your target is $30,000 per year, or $120,000 total. You buy:

• $30,000 face of 13-year STRIPS (junior year)
• $30,000 face of 14-year STRIPS (senior year in high school, first college year)
• $30,000 face of 15-year STRIPS (sophomore year)
• $30,000 face of 16-year STRIPS (junior year)
• $30,000 face of 17-year STRIPS (senior year)

Total cost: roughly $80,000–$90,000 (depending on yields). In years 13–17, you receive $30,000 per year, exactly matching the education costs. No reinvestment risk, no market risk (the payments are locked in at today's yields).

STRIPS in retirement planning

STRIPS can also be used to fund a retirement income stream. If you need $50,000 per year starting at age 65 (in 30 years) and lasting 25 years (until age 90), you can buy a STRIPS ladder:

• $50,000 face of 30-year STRIPS (age 65, first retirement year)
• $50,000 face of 31-year STRIPS (age 66)
• ...continuing through...
• $50,000 face of 54-year STRIPS (age 89)

This ensures a predictable income stream, immune from interest-rate and reinvestment-rate risk. It's less efficient than a traditional annuity (which pools longevity risk), but it offers more transparency and control.

Conclusion: a specialized tool for known future obligations

STRIPS are not an investment for everyone. They are best suited to investors with specific, long-dated liabilities and the ability to hold through periods of market volatility without panic-selling. The tax complexity (phantom income in taxable accounts) makes them preferable in tax-deferred accounts. For liability matching—college costs, retirement income, pension obligations—STRIPS are among the best tools available to lock in a known outcome today.

STRIPS decision flowchart

Related concepts

• What Government Bonds Are
• Treasury Bonds

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