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LOS c: Describe how stripped Treasury securities are created and distinguish between coupon strips and principal strips.

Which of the following statements about the taxation of separate trading of registered interest and principal of securities (STRIPS) is FALSE?

A)	The STRIPS program began in 1985.

B)	Implicit interest taxation is a paramount issue for pension plans.

C)	Treasury STRIPS can be based upon either coupon payments or principalpayments.

Pension plans are not taxable entities so they do not have to worry about implicit interest taxation. Both of the other statements are true.

A)	Designated government securities dealers can buy treasuries, strip out the coupons and principal, and reissue these stripped cash flows as zero-coupon bonds.

B)	Taxable investors holding zero-coupon bonds can have negative cash flows prior to maturity.

C)	The U.S. Treasury auctions 10-year Notes weekly.

U.S. Treasury Notes are issued quarterly. Both of the other statements are true. It is possible that taxable investors will have negative cash flows from holding zero-coupon securities, since there is no cash income, but taxes must be paid at least annually on the implicit interest.

Which of the following statements regarding separate trading of registered interest and principal of securities (STRIPS) is TRUE? A 20-year Treasury bond can be used as the basis for:

A)	40 coupon strips and 1 principal strip.

B)	40 principal strips and 1 coupon strip.

C)	41 coupon strips.

A 20-year Treasury bond can be used as the basis for 40 coupon strips and 1 principal strip.

Which of the following refers to the U.S. Treasury bonds that are sold in the form of zero-coupon securities?

The U.S. Treasury does not issue zero coupon notes and bonds, therefore investment bankers began stripping the coupons from Treasuries to create synthetic zeros to meet investor demand. The Separate Trading of Registered Interest and Principal Securities (STRIP) was introduced in 1985 to meet this need.

Which of the following statements regarding U.S. Treasury securities is least accurate?

A)	Due to the way Treasury STRIPS are taxed, U.S. investors may face negative cash flows before the maturity date.

B)	The U.S. Treasury issues zero coupon notes, but not bonds.

C)	A 5-year Treasury note can be stripped into 11 different zero coupon securities.

The Treasury does not issue zero-coupon notes or bonds. That is why STRIPS were created. A 5-year Treasury note can be stripped into 11 zero coupon securities, consisting of its 10 coupon payments and the principal repayment. The U.S. Internal Revenue Service regards the accrued interest on a zero coupon security as income on which the security holder must pay taxes even though he has not received a cash interest payment.