Treasury STRIPS vs Treasury Notes: Cash Flows, Duration and Reinvestment Risk

Two shapes of the same credit

A Treasury note is a promise to pay a fixed coupon every six months and to repay principal at maturity. A Treasury STRIP is one slice of that promise, sold on its own: a single payment, at a single date, with nothing in between.

TreasuryDirect’s description of STRIPS is direct. Financial institutions and government securities brokers or dealers separate — “strip” — the interest and principal portions of a Treasury note or bond and sell each as a separate security. The pieces trade as zero-coupon securities.

The important consequence is that the credit is unchanged. Both instruments are obligations of the U.S. Treasury. What differs is the timing of the cash and therefore the sensitivity to interest rates.

How a note becomes several securities

Take a ten-year note with a 4% coupon and a $1,000 face value. It produces twenty semiannual coupon payments of $20 and one principal payment of $1,000 at maturity. Strip it and you get twenty-one separate zero-coupon securities: twenty coupon strips, each paying $20 on its own date, and one principal strip paying $1,000 in ten years.

Each piece can be bought and sold independently. An investor who needs $1,000 in exactly ten years can buy the principal strip and ignore the rest. An investor who needs $20 in eighteen months can buy that single coupon strip.

Two constraints come with the structure. Only fixed-principal Treasury securities — notes, bonds and TIPS — can be stripped; bills and floating rate notes cannot. And the stripping and reassembly happen in the commercial book-entry system, not in TreasuryDirect, so access to STRIPS runs through a financial institution, broker or dealer that handles government securities rather than through the retail TreasuryDirect platform.

Because the pieces are separable, they must also be reassemblable. A stripped security can be reassembled into a single security once the institution holds every remaining separate piece of the original. That two-way door is what ties the price of the parts to the price of the whole.

Pricing the parts against the whole

Here is the arithmetic that keeps the market honest. Price the note and each of its strips at a 4% yield, compounded semiannually — the same yield at which this note trades at par.

The parts add to the whole to the cent. If the strips traded at $990 in total while the note traded at $1,000, a dealer could buy the strips, reconstitute the note and sell it. If the strips traded at $1,010, the dealer would do the reverse. The reconstitution channel is why the discrepancy cannot persist beyond the cost of executing it.

Duration: why the zero moves more

Duration measures how much a bond’s price responds to a change in yield. For a coupon bond, Macaulay duration is the present-value-weighted average time until the cash flows arrive. For the note above, at a 4% yield:

• Macaulay duration = 8.3392 years
• Modified duration = 8.1757

The modified duration is the first-order price sensitivity: a 1 percentage point rise in yield implies roughly an 8.18% fall in price, before convexity.

For a zero-coupon bond, all the value arrives at maturity, so the weighted average time is simply the maturity. The principal strip has a Macaulay duration of 10 years and a modified duration of 10 / 1.02 = 9.8039.

That gap is not a technicality. It is the difference between owning a stream and owning a single dated payment. At a 5% yield:

The strip loses more for the same move in yield because it has no early cash flows to cushion the discounting. The duration guide sets out the full convexity adjustment; the point here is directional: at equal maturity, the zero is the more rate-sensitive instrument.

Reinvestment risk, in numbers

A coupon note returns more than its coupons if they are reinvested, and less if they are not. The variable is the rate at which each $20 can be redeployed between now and maturity. Assume the note is held to maturity and every coupon is reinvested at a single rate for the remaining term.

The $45.57 gap between the 2% and 4% cases is not a market loss. It is the realised reinvestment outcome of a decision made twenty times over ten years, each time without knowing the future rate. The coupon itself never changed. Only the rate earned on it did.

A STRIP has none of this. There are no coupons, so there is nothing to reinvest, and the amount received at maturity is known at purchase if the security is held to maturity. That certainty is the product.

The trade is risk-shape, not risk-amount

Neither instrument is safer in a general sense. They distribute the risk differently.

A note pays you cash along the way. That cash is a realised return you can spend, but it must be reinvested, and the future rate is unknown — that is reinvestment risk. The note also has a shorter duration, so its price moves less for a given yield change.

A STRIP pays nothing until maturity. Held to maturity, its total return is fixed at purchase, with no reinvestment decisions. But its duration equals its maturity, so its market price moves more while you hold it. If you might need to sell before maturity, that price risk is real and it is larger than the note’s.

The practical test is the liability. If you have a known payment at a known date, the zero matches it and the coupon note does not — the note’s coupons would have to be reinvested at unknown rates to reach the same amount. If you need income now, the note produces it and the zero does not.

A note on tax

A STRIP accrues value steadily and pays nothing until maturity. A note pays cash every six months. That difference in timing does not by itself change the tax year in which the income is recognised.

TreasuryDirect states that interest earned on STRIPS must be reported in the year in which it is earned, and that each STRIP is taxed in the same way as the entire security. The practical consequence is that a holder may owe tax on value that has accrued but has not been paid in cash — the annual increase in the security’s value. A note holder receives the cash with which to meet the corresponding tax.

This article is not tax advice, and the treatment depends on your jurisdiction and account type. The point is narrow and worth checking with an adviser: the STRIP’s lack of cash payments does not mean the absence of a taxable event.

Where STRIPS fit in a portfolio

The use case is a dated obligation. A known payment in ten years — a tuition bill, a contractual liability, a defined future outlay — can be matched with a principal strip maturing in ten years. The amount at maturity is fixed, the credit is the Treasury’s, and there is nothing to manage in between.

The misuse is treating a long zero as a low-risk substitute for cash. A thirty-year strip has a modified duration near 30 at a 0% yield and still well above 20 at realistic yields. Its price can move by a fifth on a single percentage point of yield. That is not a cash equivalent.

For a fund wrapper, the same logic appears in the tokenised treasuries guide, where short-dated government exposure is packaged as a transferable token. For the auction mechanics that produce the underlying notes, the T-bill auction guide covers the bidding and settlement process.

How these sources were checked

The description of STRIPS — separation of interest and principal, sale as zero-coupon securities, the $100 minimum face amount in multiples of $100, the exclusion of bills and floating rate notes, the commercial book-entry channel, reassembly, and the tax-year statement — comes from TreasuryDirect’s Treasury STRIPS page, retrieved 2026-10-24. The coupon and maturity conventions for notes come from TreasuryDirect’s Treasury Notes page, retrieved 2026-10-24. The 10-year constant maturity yield was 4.96% on 2026-10-22 according to FRED series DGS10, retrieved 2026-10-24; the worked example uses a round 4% so the arithmetic can be followed without a calculator.

Every price, duration and reinvestment figure in the tables was computed from the stated cash flows and the stated yield, using semiannual compounding. They are illustrative, not quotations of any specific security on any date.