A portfolio manager at Superior Trust Company is structuring a fixed income portfolio to meet the objectives of a client. This client plans on retiring in 15 years and wants a substantial lump sum at that time. The client has specified the use of AAA rated securities.
The portfolio manager compares coupon U.S. Treasuries with zero coupon stripped U.S. Treasuries and observes a significant yield advantage for the stripped bonds:
Term (Years) |
Coupon U.S. Treasuries |
Zero Coupon Stripped U.S. Treasuries |
3 |
5.50% |
5.80% |
5 |
6.00 |
6.60 |
7 |
6.75 |
7.25 |
10 |
7.25 |
7.60 |
15 |
7.40 |
7.80 |
30 |
7.75 |
8.20 |
Briefly discuss why zero coupon stripped U.S. Treasuries could yield more than coupon U.S. Treasuries with the same final maturity.