STRIPS is the acronym for “Separate Trading of Registered Interest and Principal Securities”. These are zero-coupon securities (zeros) of the U.S. Treasury created by physically separating the principal and interest cash flows. The process of stripping is known as coupon stripping.
All new Treasury bonds and notes with maturities of 10 years and longer are eligible to be stripped and are direct obligations of the U.S. government. Under the STRIPS program, the holder of any eligible security can request that the U.S. Treasury create separate book-entry instruments for all of the principal and interest cash flows. The principal and interest portions of these instruments are assigned separate identification (CUSIP) numbers and may be owned and traded separately.
STRIPS and other zero-coupon instruments can be tailored to meet a wide range of portfolio
objectives because of their known cash-flow value at specific future dates. Specifically, they
appeal to investors who want to lock in a terminal value without incurring the risk associated
with reinvesting intervening cash flows.
They also appeal to investors with definite opinions on interest rates, as prices of STRIPS
are highly sensitive to changes in interest rates. Due to this high sensitivity to interest-rate
changes, disproportionately large long-maturity holdings of Treasury derivatives such as STRIPS, CATS, or TIGRs in relation to the total investment portfolio or total capital of a depository institution would be considered an imprudent investment practice.
The STRIPS program provides that all stripped securities be maintained in a book-entry format.
For maintenance and transfer purposes, each marketable Treasury security has a unique identification (CUSIP) number. Under STRIPS, each principal and interest component is assigned a separate CUSIP number. All STRIPS are traded over the counter (OTC), with the primary government securities dealers being the largest and most important market participants. A small group of interdealer brokers disseminates quotes and broker trades on a blind basis between market participants. Arbitrageurs continually monitor the prices of STRIPS and underlying coupon-bearing bonds, looking for profitable opportunities to strip or reconstitute. Price transparency is relatively high for STRIPS since several information vendors disseminate prices to the investment public.
Reference: Federal Reserve Board