treasury strips

[afterworkguinness]

Hello,
I'm hoping someone can clear up a couple points abot tstrips for me.

a. I thought only investment banks strip treasury bills, bonds not the treasury itself ? this is the impression I got fom a few websites, not to doubt BT or the source reading (which I don't have)

b. can someone elaborate on the scenario where an investor delivers a set of dtrips and has the treasury convert them into a coupon bond ? (investor can deliver a set of strips and have treqsury reconstitute them)

thanks

 

[ShaktiRathore]

1. The treasury strips are innovative financial instruments they are created through financial engineering from Treasury bonds/bills, this is the practice of many investment banks who wants to offer their customers with many sources of investments. The treasury just issues the bonds and bills and does not strip but this is the work of the investment banks who are in the business.
2. The other way round that is reconstituting from a set of strips i have not heard if this is done by the banks but its possible. This would be one of the rare instruments refer:http://www.treasurydirect.gov/instit/marketables/strips/strips.htm

thanks

 

[afterworkguinness]

Thanks for your reply, that clears a couple things up. From reading that website, this is how I understand the reconstitution on strips, can you verify if I've got it right ?

A. Treasury issues fixed coupon bond ie: $100,000 10 year 5% coupon pays semi annually
B. Investment bank Foo buys the bond ans strips it creating 20 CSTRIPS and 1 PSTRIP
C. 6 months goes by and 1 of the CSTRIPS has matured. The investment bank wants to no longer offer the strips but the whole (remaining) T-Bond and they submit the remaining CSTRIPS and the PSTRIP to the treasury for reconstitution ?

If this is correct, why is reconstitution necessary ? If the bank changes their mind and instead of selling strips they want to sell the whole T-Bond, why does the treasury need to get involved ?

Cheers

 

[ShaktiRathore]

refer to the link:http://forum.bionicturtle.com/threads/p-strips-c-strips.208/ David has explained that arbitrage is one of the reasons for reconstitution of the strips.
As the need arises i think that the bank wants to reconstitute, lack of investors demand for strips or that cost of stripping and selling is far more than benefits earned by the bank, lack of demand creates high liquidity costs for investors,requests for reconstitution from primary dealers due to some specific reasons..If bank own the TBond than stripping results in all coupons passing to investors but when reconstitueed the bank has the bond itself back so that the portfolio duration increases for the bank now so faces more interest rate risk because the bank cannot transfer the copuns on to the investor and also faces reinvestment risk so that there is overall increase in the duration of the bank portfolio.
thanks

 

[afterworkguinness]

Thanks, makes sense now. I still don't see why the investment bank needs to involve the treasury to strip or reconstitute, as in why the bank can't just do it itself, but that's not really important right now.