Treasury STRIPS Explained: How Zero-Coupon Government Bonds Work

Most Treasury securities pay interest twice a year and return principal at maturity. STRIPS take that same bond and break it into separate pieces: each individual interest payment becomes its own security, and the final principal repayment becomes another. Every one of those pieces trades independently as a zero-coupon bond, meaning it is sold at a discount and pays nothing until it matures at full face value.

The name stands for Separate Trading of Registered Interest and Principal of Securities, a program the U.S. Treasury introduced in 1985. The Treasury does not sell STRIPS directly to the public at auction. Instead, eligible securities, such as Treasury notes and bonds with maturities of 10 years or more, and Treasury Inflation-Protected Securities, can be converted into STRIPS by financial institutions and government securities brokers and dealers through the Federal Reserve's book-entry system. Investors then buy and sell these components in the secondary market, typically through a brokerage account.

How the Math Works

Because a STRIP pays nothing until maturity, its price reflects the present value of that single future payment, discounted at the prevailing interest rate for its maturity. If a 10-year STRIP has a face value of $1,000, an investor might pay a few hundred dollars for it today, depending on where interest rates stand, and then receive the full $1,000 only when the security matures. The difference between the purchase price and the face value represents the investor's total return.

• No reinvestment risk during the holding period, since there are no coupon payments to reinvest at uncertain future rates.
• Price moves more sharply with interest-rate changes than a comparable coupon bond, because all of the security's value is concentrated in one future payment rather than spread across periodic coupons.
• Original issue discount rules generally require holders to report imputed interest income each year, even though no cash arrives until maturity, which can create a tax bill without matching cash flow in taxable accounts.

Who Tends to Use STRIPS

STRIPS are often used by investors and institutions trying to match a specific future liability with a specific maturity date, such as funding a known expense or a pension obligation years from now. Because each STRIP has a fixed, known payout at a fixed date and carries the credit backing of the U.S. government, it offers a high degree of certainty about what an investor will receive, assuming the security is held to maturity. This predictability is one reason STRIPS show up in strategies like laddering future cash needs or constructing portfolios designed to offset long-dated liabilities, a practice sometimes called cash-flow matching or immunization.

Retail investors sometimes use STRIPS, or similar zero-coupon Treasury products packaged by brokerages, to plan for a specific goal, such as a future tuition payment or a retirement date, where knowing the exact amount that will be received on a specific future date is more important than earning periodic income along the way.

Key Risks and Considerations

• Interest-rate sensitivity: STRIPS can swing more in market value than coupon-paying bonds of the same maturity if sold before maturity, since all the value sits in one distant payment.
• Tax treatment: the IRS generally treats the annual accretion in value as taxable interest income, known as original issue discount, even though the investor receives no cash until the bond matures. Holding STRIPS in a tax-advantaged account such as an IRA can sidestep this annual phantom-income issue.
• Liquidity: STRIPS trade over the counter through dealers rather than on a centralized exchange, and liquidity can vary by specific maturity.
• No direct purchase from Treasury: STRIPS cannot be bought through TreasuryDirect; they are created and traded through the broker-dealer market, so investors need a brokerage account that offers access to them.

This article is for general information and educational purposes only. It is not investment, tax, or legal advice. Investors should consult the official U.S. Treasury resources, a qualified financial professional, or a tax advisor before making decisions involving STRIPS or any other security.