What are 'Interest Only (IO) Strips'

Interest only (IO) strips are the interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments. The periodic payments of several bonds can be "stripped" to form synthetic zero-coupon bonds.

Also, an IO strip might be part of a larger collateralized mortgage obligation (CMO), asset-backed security (ABS) or collateralized debt obligation (CDO) structure.

BREAKING DOWN 'Interest Only (IO) Strips'

Financial engineers, such as Wall Street dealers, frequently strip and restructure bond payments in an effort to earn arbitrage profits. Zero-coupon Treasury strips are an important building block in many financial calculations and bond valuations. For example, the zero coupon or spot-rate Treasury yield curve is used in option-adjusted spread (OAS) calculations and for other valuations of bonds with embedded options.

RELATED TERMS
  1. Coupon Stripping

    The separation of a bond's periodic interest payments from its ...
  2. Strip

    1. For bonds, the process of removing coupons from a bond and ...
  3. Treasury STRIPS

    An acronym for 'separate trading of registered interest and principal ...
  4. Futures Strip

    The sale or purchase of futures in sequential delivery months ...
  5. Servicing Strip

    A security created by the stream of cash flows that result from ...
  6. Strip Bond

    A bond where both the principal and regular coupon payments--which ...
Related Articles
  1. Investing

    What are Treasury STRIPS?

    STRIPS is an acronym that stands for Separate Trading of Registered Interest and Principal Securities.
  2. Investing

    Introduction To STRIPS

    STRIPS provide an alternative form of bond for fixed-income investors who need definite cash flows at specific times. Read the article to find out how.
  3. Investing

    All About Zero Coupon Bonds

    Zero-coupon bonds are bonds that do not make any interest payments (which investment professionals often refer to as the "coupon") until maturity. For investors, this means that if you make an ...
  4. Investing

    Understanding Structured Finance

    Structured finance refers to a complex financial transaction involving large financial institutions and companies with unique needs.
  5. Investing

    Government Bond ETFs to Date 2016 Performance Review (ZROZ, EDV)

    Find out how government bond exchange-traded funds (ETFs) are performing YTD in 2016, and which are the best and worst performers.
  6. Investing

    Understanding Collateralized Mortgage Obligations

    A collateralized mortgage obligation (CMO) is a security consisting of a pool of mortgages organized by maturity and risk.
  7. Investing

    How Bond Market Pricing Works

    Learn the basic rules that govern how bond prices are determined.
  8. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
  9. Trading

    Strip Options: A Market Neutral Bearish Strategy

    Strip Options are market neutral trading strategies with profit potential on either side price movement, with a "bearish" skew.
  10. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
RELATED FAQS
  1. What is a stripped bond?

    The quick answer to this question is that a stripped bond is a bond that has had its main components broken up into a zero-coupon ... Read Answer >>
  2. How does an investor make money on a zero coupon bond?

    Learn about investing in zero-coupon bonds, exactly how they work as an investment vehicle, and their advantages and disadvantages ... Read Answer >>
  3. What is the difference between a zero-coupon bond and a regular bond?

    The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons, or interest ... Read Answer >>
  4. What's the difference between a collateralized debt obligation (CDO) and a collateralized ...

    Find out how a collateralized mortgage obligation (CMO) is similar to a collateralized debt obligation (CDO), as well as ... Read Answer >>
  5. What is the difference between a collateralized debt obligation (CDO) and an asset ...

    Discover the relationships between asset-backed securities (ABS), collateralized debt obligations (CDOs) and mortgage-backed ... Read Answer >>
  6. Are all mortgage backed securities (MBS) also collateralized debt obligations (CDO)?

    Learn more about mortgage-backed securities, collateralized debt obligations and synthetic investments. Find out how these ... Read Answer >>
Hot Definitions
  1. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  2. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  3. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  4. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  5. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  6. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
Trading Center