Treasury STRIPS Explained: Zero-Coupon Bonds, Pricing, and Tax

STRIPS stands for Separate Trading of Registered Interest and Principal of Securities. A financial institution can separate eligible Treasury principal and interest payments into individual book-entry securities. Instead of owning a note that sends a coupon every six months and returns principal at maturity, you can own a claim on one scheduled payment. TreasuryDirect records the program and its mechanics on the official STRIPS page.

Consider a hypothetical 10-year fixed-rate note with $1,000 face value and a 4% annual coupon paid semiannually. It is scheduled to pay $20 every six months for 20 periods and return $1,000 at maturity. If all payments are stripped, the result is 21 separate claims: 20 coupon STRIPS and one principal STRIP. They have separate CUSIPs and maturity dates. A coupon STRIP pays its stated coupon amount once; the principal STRIP pays the face amount once.

The investor buying one piece does not receive the other 20 payments. Someone holding the principal STRIP gets the $1,000 principal at maturity, while the separate coupon holders get the $20 payments on their own dates. The parent note's original schedule explains where the pieces came from; after stripping, each piece is its own zero-coupon security.

Both a STRIP and a Treasury bill have no periodic coupon and make a single payment at maturity. Their price relative to that payment depends on the yield and can be above or below it. A bill is issued directly as a short-term Treasury security. A STRIP is one payment separated from an eligible note, bond, or TIPS issue. The similar payoff shape does not make them the same instrument, maturity range, or issuance process.

Treasury's program allows principal and interest payments from eligible fixed-principal notes and bonds and from TIPS to be stripped. Treasury bills and floating-rate notes are not eligible for the STRIPS program. A TIPS principal STRIP is also different from the fixed $1,000 example below: TIPS principal adjusts with inflation, so the maturity amount is not simply a fixed nominal payment. Check the security and its payment terms before treating any quoted amount as a fixed future dollar value. TreasuryDirect's marketable-securities glossary is a useful reference for the related Treasury terms.

For a fixed nominal payment with no interim cash flows, the basic present-value relationship is:

Price = maturity payment / (1 + yield per period)^(number of periods)

Suppose an investor considers a hypothetical $1,000 principal STRIP due in 10 years. At a 4% nominal annual yield compounded semiannually, the yield per half-year is 2%, and there are 20 periods:

$1,000 / (1 + 0.04/2)^20 = about $672.97.

That price is about $327.03 below the stated maturity payment. The difference is the discount implied by the assumed yield and holding period; it is not a coupon paid along the way. If the investor holds this nominal STRIP to maturity and Treasury pays as promised, the payment is $1,000. A sale before maturity happens at the market price then available, which may be below or above the original purchase price.

This calculation assumes a fixed nominal payment, a 4% yield, semiannual compounding, a purchase on a coupon-date-equivalent basis, and no accrued interest, transaction charge, or tax. Real quotes use market conventions and dealer prices, so this arithmetic illustrates the relationship rather than quoting an available security.

The quoted yield is a way to express the price-to-payment relationship under a stated convention. It does not mean the account receives a 4% cash deposit every year. There is no coupon to spend or reinvest before maturity, so a STRIP can remove the question of what rate future coupons will earn while creating a different planning constraint: the investor must fund expenses from other cash or sell part of the position. Holding to the stated date also does not erase inflation, tax, or issuer-payment risk.

When comparing two quotes, match the exact payment date and settlement date, not just a rounded label such as “10-year.” A STRIP with 9 years and 11 months remaining can have a different yield and price from one with exactly 10 years. Check whether the displayed yield is nominal or effective and whether it assumes semiannual or another compounding basis. Comparing a price on one convention with a yield from another can make a correct calculation appear inconsistent.

A long-dated principal STRIP has one distant payment and no earlier coupons. Its value therefore depends heavily on discounting that one future amount. For the same hypothetical 10-year $1,000 payment, increasing the nominal yield from 4% to 5%, with semiannual compounding, lowers the calculated price from about $672.97 to $610.27, a decline of about 9.3%. Lowering the yield to 3% raises it to about $742.47, about 10.3% above the 4% price.

For comparison, a hypothetical 10-year $1,000 note with a 4% coupon is priced at $1,000 when its yield is 4%. At a 5% yield and semiannual coupons, its theoretical price is about $922.05, down roughly 7.8%. The note's earlier $20 payments return some cash before year 10, so those cash flows receive less discounting over the full horizon than the STRIP's single $1,000 payment. Under these assumptions, the STRIP has greater sensitivity to the same yield change.

Duration summarizes a bond's approximate price sensitivity to a small yield change, while convexity describes how that sensitivity changes as yields move. A duration estimate is a first-order approximation, not a price guarantee. For a principal STRIP with 10 years remaining and a 4% nominal yield compounded semiannually, modified duration is about 9.80 years. A simple duration estimate for a 1 percentage point rise is therefore about a 9.8% price decline; the exact compounded calculation above gives about 9.3% because curvature matters. The price response is not perfectly symmetric for equal-sized yield rises and falls.

The comparison is useful for understanding exposure, not for ranking investments in every portfolio. A STRIP's rate sensitivity changes as it approaches maturity, and a sale can also reflect bid-ask spread, market liquidity, tax basis, and the yield buyers require that day. FINRA's bond overview discusses interest-rate and liquidity risks; Investor.gov also explains zero-coupon bond pricing and imputed interest.

An investor with a known future dollar obligation may value a Treasury payment scheduled near that date. For example, a nominal principal STRIP due in 10 years could be compared with a planned $1,000 nominal payment then. The comparison should use the expected liability date, amount, currency, and certainty of both sides. A near match can reduce the need to sell an asset on an inconvenient date, but it does not by itself make the whole plan risk-free.

Several mismatches remain possible. The liability may be larger after inflation, become due before the STRIP matures, or require cash in a different currency. A TIPS STRIP has inflation-linked principal mechanics rather than the same fixed nominal amount. If the investor sells early, the sale price will respond to yields and market conditions. And even a payment whose date matches a liability does not cover taxes, account restrictions, or unexpected expenses unless those were included in the plan.

Build the cash-flow schedule before choosing a security: list each required date and amount, distinguish nominal from inflation-adjusted dollars, then compare available maturities and the cost of buying. If the payment date and amount are uncertain, holding a single maturity may leave a timing gap. A ladder or a mix of maturities can spread dates, but introduces its own purchase, reinvestment, and maintenance decisions.

STRIPS are held in the commercial book-entry system through a financial institution, broker, or dealer. TreasuryDirect says investors cannot strip or reconstitute securities directly in a TreasuryDirect account. An institution that participates in the program performs the separation. Reconstitution combines the required remaining pieces into the eligible parent security; it is not a way to combine only a convenient subset of coupons and principal.

For example, after some coupon dates have passed, the pieces still needed to rebuild the remaining note include its remaining coupon payments and principal. The specific requirements and availability depend on the security and the institution. Before trading, confirm the exact CUSIP, maturity date, payment amount, quote convention, minimum order, fees, and whether a quoted market is firm for the quantity you want. A price shown for a small piece does not prove that a larger order can trade at the same level.

Treasury's marketable-securities FAQs and STRIPS history provide official program context. Current access and execution details should be checked with the institution handling the transaction.

For U.S. federal tax purposes, a stripped bond or coupon is generally treated as a separate debt instrument acquired for the purchase price. When its maturity payment exceeds that price, the difference is OID. In many cases, a holder must include OID in taxable interest as it accrues even though the security makes no cash payment during the year. That can create a cash-flow mismatch: tax may be due before maturity or before an early sale produces proceeds.

The amount and timing are not always found by dividing the original discount evenly by the number of years. IRS Publication 550 describes how stripped bonds and coupons are treated as separate debt instruments and explains that a purchaser's OID calculation depends on the instrument and acquisition. IRS Publication 1212 covers information and calculation methods for original issue discount instruments. Price paid, yield, acquisition date, accrual periods, prior reporting, and whether the stripped instrument is inflation-indexed can matter. The IRS instructions discuss constant-yield methods for many post-1984 stripped instruments and distinct treatment for inflation-indexed strips.

TreasuryDirect says institutions report STRIPS interest earned and TIPS principal inflation adjustments on Form 1099. IRS Publication 550 generally treats U.S. Treasury interest as subject to federal income tax and exempt from state and local income taxes, but a taxpayer's reporting can depend on account type and facts. Use the current IRS Publication 550, IRS Publication 1212, and tax guidance for the relevant account and jurisdiction; consult a qualified tax professional for an individual return. This section describes general U.S. tax mechanics, not a calculation for a particular investor.

1. Identify whether the security is a coupon STRIP, a principal STRIP, or a TIPS STRIP; do not infer this from a short label alone.
2. Match its CUSIP and payment date to the amount and type of cash flow you expect.
3. Confirm the yield convention, compounding assumption, price per $100 or per security, settlement date, minimum size, and transaction charges.
4. Measure rate exposure with duration and consider convexity, but test the actual sale price under several yield assumptions.
5. Compare nominal cash needs with inflation-adjusted liabilities and check whether an early sale could be necessary.
6. Estimate tax accrual and cash timing separately from investment cash flows; use current IRS instructions for the acquisition details.

The key distinction is between a scheduled maturity payment and today's sale value. A STRIP can make a future cash-flow date clear, but its market price changes before then and its tax accrual may not wait for the cash payment. For how Treasury auctions allocate new securities, see how to read Treasury auction results. For the difference between a Treasury note or bond and its futures contract, see Treasury futures versus cash Treasuries.