WHY ARE STRIPS POPULAR?

There are a number of reasons why STRIPS are popular with investors. To begin with, the fact that STRIPS are backed by U.S. Treasury securities makes them very high-quality debt instruments. Even the slight default risk that was possible with privately issued zeros in the 1980s was removed with the book-entry STRIPS system.

Second, STRIPS allow investors to take advantage of the earnings of Treasury bills and bonds without a large outlay of capital. While it takes a minimum investment of $10,000 to purchase Treasury bonds, for instance, a STRIP based on the interest of the T-bond may cost only a few hundred dollars.

The fact that STRIPS are zero coupon securities means that you know in advance what the future value of your investment will be. The STRIP will always pay its face value at maturity, and your return will be the difference between the face value and the discounted price you paid for it. By contrast, if a bond issue is called, the investor is out the amount of interest the bond would have paid to maturity. The predictable returns of STRIPS can be beneficial in planning for specific goals.

Another advantage of STRIPS over the Treasury securities they are based on is the variety of maturity dates available. Since STRIPS can be based on interest payments, there is no need to wait decades for maturity, and you can choose from a range of maturity dates that will offer differing returns. The returns on STRIPS also represent an automatic reinvestment of interest. There is no reinvestment risk -- the risk that the cash flow produced by an investment would have to be reinvested at a lower rate of return.

There is an active secondary market for STRIPS, where their prices can be quite volatile based on returns, maturity, and changes in general interest rates. Also, STRIPS are eligible for inclusion in tax-deferred retirement plans, in which their value would grow tax-free until your retirement.