Let's visualize the stripping process using a practical example. Imagine we have a two year US treasury security with a 4.8% coupon paid semi-annually, and it's currently priced at 99.8% of its face value. When we strip this two year bond, each coupon payment and the principle amount at maturity becomes a separate zero coupon security. Here is a high level description of the process. A bank first purchases this eligible government bond, specifically with the aim of using it for stripping, and then separates the bonds cash flows. Stripping each semi-annual coupon from the principle. In this case, there are four coupon payments of 2.4% over the bonds two year life, plus a final principle repayment of 100% at maturity. Each coupon payment and the principal amount is now treated as an independent zero coupon bond. Each of these stripped components can now be sold by the bank individually to different investors, providing them with a range of zero coupon securities across different maturities. The individual prices of these zero coupon securities will reflect the present value of each payment based on the prevailing interest rates for the respective maturities. Conceptually, the sum of the prices of all these zero coupon bonds should be identical to the price of the original coupon bond. Since all of the strips together represent all of the cash flows of the bond. This pricing parity is a key principle in the stripping process, ensuring that no value is lost or created in the transformation process from bond to STRIPS or back again. While the stripping process might seem straightforward at first glance, it involves several important steps and systems working together in the background. Let's walk through the key stages involved in transforming a standard treasury security into individual STRIPS components in the US. The US Treasury first determines which treasury securities are eligible for stripping. This eligibility typically applies to treasury notes and bonds with longer maturities, which are more suitable for conversion into multiple strips components. To initiate the stripping process, a bank purchases an eligible treasury security. This can be motivated by specific client demand for strips or to enhance liquidity in the strips market.

The bank then submits a request to the Federal Reserve, which acts as the operational arm of the treasury in managing the stripping process. This request formally asks for the treasury security to be separated into its individual coupon and principle components. Once the stripping request is approved, the Federal Reserve assigns unique CUSIP numbers to each individual STRIPS component. QIP numbers, which serve as unique identifiers for stocks and registered bonds in the US and Canada are essential for tracking and trading each separated coupon and principle payments as an independent security. After the CUSIP numbers are assigned, the newly created strips components are recorded in the US Treasury's book-entry system. This electronic system maintains an official record of ownership and transfer for all treasury securities, eliminating the need for physical certificates and streamlining the settlement process. Finally, the newly created strips are made available for sale in the market. Each separated coupon and principle payment can now be traded individually as a zero coupon bond, giving investors access to a variety of maturities and enabling them to tailor their portfolios with precision. This detailed process facilitated by the Treasury and the Federal Reserve ensures that STRIPS are accurately tracked, easily tradable, and fully integrated within the broader financial system. The operational support provided by the Fed including maintaining records and issuing new CUSIP numbers plays a critical role in making strips a reliable and flexible option for investors.