They’re just government-backed zero coupon bonds. They pay no interest along the way…and then, at the very end, after being sold at a meaningful discount to par, they pay par, and everyone goes away happy. Ish.
STRIPS stands for:
Separate
Trading
Registered
Interest
Principal
Of Securities
STRIPS. Yeah, not nearly as exciting as you were hoping.
STRIPS became a thing in 1985, as the government’s zero-coupon vehicle of choice, replacing older forms of money raising. The basic idea was to feed an ever more complex hunger among investors wanting different flavors of debt food, and stripping principal in various forms helped to at least partially feed that beast. In this case, the coupons can be stripped from the principal. So, in the case of, say, 15-year paper, there are 31 elements of payment, or 31 payments to be made, where 30 of them are coupons, or semi-annual interest payments, and those can be packaged as one suite of product...and then there's a final payment of principal.
Investors can buy them separately or combined as it suits their needs. And you can imagine having just bought a building that carries a tax-deductible interest cost via debt procured to buy it. That interest cost to the company is $100 grand a month. In order to defease that interest cost, the company might also buy a STRIPS, where they are just buying the coupons from it for an offering that pays, say, 400 grand twice a year in stripped coupons. That way, $800k of the total $1.2 million owed in mortgage payments on the building are defeased, and the company only has to stress about the remaining 400 grand to cover their brand-spanking-new building interest costs.
At the other end of the liquidity spectrum, a company might not need any cash for 15 years, and they are happy just getting very safe, U.S. Government-backed interest in buying the principal at a discount, and then, 15 years later, getting back par.
Either way, it’s nice to have a little bit of cash left at the end of the day, especially if you’re planning to stop by the Zero-Coupon Bondage Parlor.
Related or Semi-related Video
Finance: What are T-Notes, T-Bonds and T...17 Views
Finance allah shmoop what are t notes t bills and
tips All right we'll see that tea in there Well
it stands for treasury and all of these air one
flavor or another of government debt that is the u
s government raises cash for itself teo fix roads build
bridges and erect statues of lebron james dunking on the
statue of liberty or you know whatever else he thinks
the public wants or needs it does that by auctioning
off these debt securities with the promise of its full
faith and credit to pay back the money is the
paper specifies well t notes are quote mid range unquote
paper in that they generally have maturity ease of two
three five seven and ten years that's a teen note
t notes carry a stated interest rate and look a
lot like a normal corporate bond paying interest twice a
year T bills on the other hand are generally very
short term paper usually coming due within a few days
all the way up to a year they're sold or
auctioned at a discount meaning that the t bill might
promise to pay a thousand bucks if it comes due
In six weeks you might pay nine hundred ninety six
dollars for it and you get a whopping fee Four
bucks an interest for your six weeks hard work of
owning that t bill and just you know sitting there
kind of looks like a zero coupon bond Okay so
now we have tips that's tips treasury inflation protected securities
tips as in show us your tips getting Why do
we have such a thing Well the problem with super
duper safe bonds like those of the u s government
is that investors holding them a long time often do
worse after taxes than inflation meaning that if inflation is
growing at three percent a year in their bonds are
only returning one percent a year after tax while then
the investors actually losing two percent a year in buying
power and that's a problem in nineteen nineties when investors
started to realize this issue well they began Tio you
know stop buying u s government bonds and that's a
huge problem for a country that desperately needs to borrow
cash all the time So rather than risk a liquid
marketplace where there's just no buyers buying government paper uncle
Sam created tips which basically adjust the end value of
the principle that investors get based on the c p
i or consumer price index which is a measure of
the average selling prices of a carton of milk a
gallon of fuel a dozen eggs and a grand slam
breakfast at denny's Basically what happens is that the price
of the principal the investor gets back goes up with
inflation over time So they're not losing buying power and
that's a big deal That's it go Enjoy your grand 00:02:33.995 --> [endTime] slam It'll be fourteen thousand dollars in fifty years
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STRIPS are government-backed, zero coupon bonds. And yes, they keep their clothes on.