No. of Recommendations: 3
True, there are no coupons but there is imputed interest annually.
I'm not sure who benefits from STRIPS. They are based on other Treasury securities, so wouldn't they have lower yield after the financial institution takes its cut?
As for the cut, I think it's one of those businesses with flows so large that the cut is likely pretty microscopic as a percentage. Like the repo market.
I didn't know they hit individuals with imputed interest...seems a bit harsh to pay tax on money you didn't get! But it's still useful for lots of pension funds and the like since so many of those portfolios are not taxed annually. And there might be a lot of the demand for the coupon streams, so for all I know one half (the principal or the coupon stream) is sold at a mild loss to get the mild profit on the other half.
The analogy is the dividend futures market in Europe. You can make a multi-year bet on what the European stock index aggregate dividends will be several years in the future. These tend to be perennially underpriced, since there is a much larger population of big money players that wants to hedge their dividend streams than there are people willing to take the other side of the trade and bet that dividends will be normal in future. Remarkably close to a free lunch, if bought at the right moment. Not every year, of course, but on average.
Jim
