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STRIPS and TIPS. Ming Fu April 30th. STRIPS = S eparate T rading of R egistered I nterest and P rincipal of S ecurities. Introduction of STRIPS. Coupon Stripping. Principal STRIPS (hen). Treasury B ond. Coupon STRIPS (eggs). History of STRIPS . COUGARs - PowerPoint PPT Presentation
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Ming FuApril 30th
STRIPS and TIPS
STRIPS = Separate Trading of Registered Interest and
Principal of Securities
Introduction of STRIPS
Principal STRIPS(hen)
Coupon STRIPS (eggs)
Treasury Bond
Coupon
Stripping
History of STRIPS
TIGRsBy Merrill Lynch
Treasury Income Growth Receipts
CATSBy Salomon Brothers
Certificates of Accrual on Treasury Securities
COUGARsBy A.G. Becker Paribas
Coupon Government Accrual Receipts
LIONsBy Lehman Brothers
Lehman Investment Opportunities Notes
DOGsDibs On Government Securities
An Example of STRIPS
U.S. Treasury Bond3 Years to Maturity
Semiannual Coupons
An Example of STRIPS (cont’d)
Year Price of Treasury bonds Price of Treasury STRIPS
0.5 $60/(1.04)1 = $58 $60/(1.020)1 = $59
1.0 $60/(1.04)² = $55 $60/(1.025)² = $57
1.5 $60/(1.04)3 = $53 $60/(1.030)3 = $55
2.0 $60/(1.04)4 = $51 $60/(1.035)4 = $52
2.5 $60/(1.04)5 = $49 $60/(1.0375)5 = $50
3$60/(1.04)6 = $47 $60/(1.04)6 = $47
$1000/(1.04)6 = $790 $1000/(1.04)6 = $790
Total $1,103 $1,110
• $1,000 principal with 12% Coupon rate and 8% Yield To Maturity
$7 profit !!!
Compare Yield to Maturity
Summary of STRIPS
Principal Coupons
TIPS = Treasury Inflation Protection Securitiesor
TIIS = Treasury Inflation Index Securities
First TIPS in 1997
Introduction of TIPS
U.S. Treasury Bond3 Years to Maturity
Semiannual Coupons
Adjusted Principal=Principal*(1+inflation rate)
Coupon payment=Adjusted Principal*fixed coupon rate
*Inflation based on Consumer Price Index-Urban Consumers (CPI-U)
Inflation
An Example of TIPS
Year Inflation(Annual)
Inflation(Semi-A)
Principal Coupon(Annual)
Coupon(Semi-A)
CouponPayment
0.0 $1,000 4% 2%
0.5 2% 1% $1,010 4% 2% $20.20
1.0 3% 1.5% $1,025.15 4% 2% $20.50
1.5 4% 2% $1,045.65 4% 2% $20.91
2.0 5% 2.5% $1,071.79 4% 2% $21.44
2.5 2% 1% $1,082.51 4% 2% $21.65
3.0 1% 0.5% $1,087.92 4% 2% $21.76
1025.15=1010+1010*1.5% 20.5=1025.15*2%
Year Deflation(Annual)
Deflation(Semi-A)
Principal Coupon(Annual)
Coupon(Semi-A)
CouponPayment
0.0 $1,000 4% 2%
0.5 -2% -1% $990 4% 2% $19.8
1.0 -3% -1.5% …… 4% 2% ……
1.5 -4% -2% …… 4% 2% ……
2.0 -5% -2.5% …… 4% 2% ……
2.5 -2% -1% …… 4% 2% ……
3.0 -1% -0.5% $917.83 4% 2% $18.36
An Example of TIPS (cont’d)
Deflation on TIPS
You have this safeguard at maturity: If the adjusted principal < the original principal
You are paid the original principal!Coupons are still paid based on deflationary principal.
1983-2012 U.S. CPI-U (in %)
Latest deflation in the U.S. was in 1954.
Summary of TIPS
• The great inflation hedge• No free lunch: opportunity cost
Alternative investment: municipal bonds? We will see in Marcus’s presentation soon
Reference• http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_faq.htm• http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips.htm• http://www.treasurydirect.gov/instit/research/faqs/faqs_basics.htm• http://www.raymondjames.com/fixed_income_tips.htm• http://
www.jpmorgan.com/tss/General/Tips_on_TIPS/1300313797124%2Bcorrelation+of+nominal+and+real+yields&oe=utf-8&rls=org.mozilla%3Aen-GB%3Aofficial&client=firefox-a&channel=np&hl=en&ct=clnk
• http://www.newyorkfed.org/aboutthefed/fedpoint/fed42.html• http://
www.finra.org/Investors/InvestmentChoices/Bonds/SmartBondInvesting/typesofbonds/P133240
• http://seekingalpha.com/article/107144-tips-strips-redux
Thank you!
Questions?
Appendix
35 TIPS