Principal Only and Interest Only Strips

T

the show NY

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
Two quick Q.
1. Why is a PO strip sold at a deep discount–is the discount simply to compensate the investor for not receiving an interest payment?
2. What are the cash flows/payments like under strips? Are they made periodically, or are they like zero coupon bonds where there is just one payment at the end?
Thank you!
 
1) Because your buying i.e. 100k 30 years from now. The NPV of that is going to be very much smaller compared to the future value.
2) I think one payment.
IOs and POs are usually stripped down treasuries bonds/notes. These securities pay principal at the end of its life (the PO), and interest on the principal semi-annually (IO). Market makers basically sell these different parts of the securities.
 
I was under the impression that PO cash flows occur as the payments occur. After all, the reason why POs gain value is that prepayments increase. If PO payments do not occur until the end, then it seems like it would not matter if prepayments increase. Same idea with the IO–I thought that payments occur semiannually based on the principal outstanding, which is why high prepayments decrease the value of an IO.
However, you are right that IOs and POs are strip securities which means that they have zero coupon structures. So what I wrote just above probably affects just to their values, not cash flows.
 
“IOs and POs are usually stripped down treasuries bonds/notes.”
Not sure what the breakdown is, but RMBS IOs and POs are a fairly sizeable chunk of that market.
In terms of RMBS POs, the principal is paid as the bond is amortized, generally quarterly.
It’s just like a usual RMBS bond, but you only receive principal quarterly, no interest (which is obviously paid to the IO stripholder).
 
Crossed posts with TheShow, he’s correct in his first assertion, but then doubts himself when he indeed was correct.
 
haha yea bipolar got me confused because i started to think of treasury strips, which are zero coupon bonds, so i dono if the same applies to IOs and POs.
so it seems like you are saying that i was originally correct in asserting that IO and PO cash flow interest or principal payments occur quarterly, semiannualy or annually and the amount that is paid depends on the prepayment rate? (high prepayment rate means more cash flow to PO, less to IO).
That’s how I understand this.
 
good explanation .. thx ..
1 more point to add .
Thats why when Interest rates go up , there are no prepayments and the price of PO falls and the price of a IO rises ( the graph in CFAI explains that )
 
You must log in or register to reply here.
Back
Top