17. In the early 1980s, at a time when interest rates were at historical highs,

Question

17. In the early 1980s, at a time when interest rates were at historical highs, investment banking firms introduced a security backed by U.S. government bonds that paid no annual interest (referred to as zero-coupon bonds), with all of the interest to be paid at the bonds' maturity date. The securities were given names such as TIGRS (Treasury Income Growth Receipts, a Merrill Lynch product), CATS (Certificates of Accrual on Treasuries, a Salomon Brothers product), and LIONS (Lehman Investment Opportu- nity Notes, a Lehman Brothers product). a. b. Why do you think securities with this feature were introduced at that time? Too often it was stated that these securities had no risk. What risks does an inves- tor face when purchasing such securities?

Explanation / Answer

Q1. In the early 1980, at a time interest rates were historical high and the investment bankers expected rates to be fall. As interest rates fell, bond and note values raised, especially those with longer maturities and fewer coupons. To get opportunity of price appreciation and deep discounted price, they bought the coupon-bearing Treasury securities and created TIGRS, CATS and LIONS. The intention behind this were to reduce the maturity of the securities by stripping coupon from coupon-bearing Treasury securities and to applied the expected discounted rates( which is low) to calculate the price of strip securities, by doing this they were sold the securities at a higher price and generated the profit from this transation.

Q2. Many factors affect the value of these stripes.                 

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