University of Central Florida (UCF) FIN4243 Debt and Money Markets Practice Exam 1

Stripped Treasury bonds are a specific type of financial instrument where the cash flows associated with the interest payments (coupons) and the principal amount at maturity are separated into distinct securities. This means that instead of the investor receiving periodic interest payments along with the principal at maturity, they receive one security that represents the future interest payment and another security that represents the principal.

This transformation allows for greater investment flexibility, enabling investors to purchase only the cash flows they desire. For instance, some investors may prefer to buy the stripped securities that provide interest payments for regular income, while others might be focused solely on the principal payment at maturity for a lump-sum investment.

The structure of stripped Treasury bonds provides these unique benefits that ordinary bonds, such as municipal bonds, savings bonds, or corporate bonds, do not offer—where the cash flows are typically not divided in this way. This separation can also enhance demand by catering to different investment strategies and cash flow requirements of various investors.