Why is the yield to maturity (YTM) of a long-term STRIP typically lower than that of a short-term STRIP?

  • 2
    Could you rephrase to explain your question a little better? – Chris W. Rea Jan 6 '17 at 20:39
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    First off, define "strip".... – keshlam Jan 6 '17 at 20:40

STRIPS is the acronym for Separate Trading of Registered Interest and Principal of Securities.

In layman's terms, a brokerage house buys a bunch of treasuries, US government bonds, and separates the coupons (the interest payments) from the principal, the final payment. This transmogrifies these 30 year bonds into a series of zero coupon bonds.

Now, to your question. Yes, the demand is so high for long term zeros that the price gets bid up and the yield twisted lower than, say, the 25 year zeros.

  • Not "typically lower".... you are seeing an inverted yield curve currently, but the curve changes with inflation expectations, monetary policy, economic conditions. – michael Jan 7 '17 at 13:36
  • Nope. You are right, but we are talking about 2 different things.The yield curve is for the natural series of treasuries. Here, we are talking about zeros. The zeroes curve isn't quite inverted, it just has a dip at the far end due to the demand for that 30 year duration. STRIPS have been around a long time. So have I. This anomaly has always been, even through times when the normal yield curve is very steep. – JoeTaxpayer Jan 7 '17 at 14:13

No, the reason is all mathematics. Yield is the geometric mean return on the STRIP to maturity, not the arithmetic mean return. The linear relationship between risk and return, under capital market theory, is based on arithmetic mean return. Geometric mean return is arithmetic mean return minus half the square of the risk (volatility) so geometric mean return is a quadratic function of risk, not a linear function. Its graph, as a function of risk, is a parabola, not the line that the graph of arithmetic mean return is. The yield curve is also approximately a parabola, because the risk (volatility) of a STRIP investment is approximately proportional to its duration.

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