Dow Jones

NEW YORK - Where has all the collateral to reconstitute Treasury bonds gone?

That's something Salomon Smith Barney may find out with the launching of an offer to buy $94.4 billion worth of coupon Strips.

Strips is the acronym for the U.S. Treasury's Separate Trading of Registered Interest and Principal Securities program, which began in 1985. It allows dealers to strip out, and trade separately, a Treasury security's interest and principal payments.

Salomon's tender offer, begun Thursday, is targeting Strips that mature between February 2001 and May 2007; , these maturities have become especially scarce and, as a result, particularly valuable.

Since the Treasury Department began buying back longer-dated government bonds this year, the Strips market has felt the supply pinch, in much the same way as other areas of the fixed-income world. Wall Street dealers have had to scramble to find the short-dated coupon Strips they need to reconstitute longer-dated Treasury bonds that can be sold back to the government in the buybacks.

Principal Strips usually trade at a slight premium to the interest payments, or coupon Strips, since they are more liquid. But coupon Strips on the front end of the curve have traded at a significant premium to principal Strips of the same maturity in recent months - a straightforward sign of a real shortage of these securities.

So where are the coupon Strips? And why has the pricing anomaly not brought the market back in line? One reason may be that buyers never intended to use the Strips as actively traded instruments and are therefore not alert to their value.

Bond market pros note that coupon and principal Strips are popular with some retail investors, but that many so-called defeasance portfolios are also big holders of these securities.

When special purpose trusts are set up to issue asset-backed bonds, the trust may sometimes hold Strips to enhance the credit quality of the transaction's more highly-rated securities. Even state lottery boards hold Strips to offset the huge payouts to winners. This approach from these kinds of investors does not lend itself to active trading.

Observers are now wondering whether the somewhat conservative investors who bought in two years ago will wake up to this opportunity now that Salomon's offer is alerting them to it.

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