The paper introduces the basic financial principles for valuing stripped securities. Treasury security strips and mortgage-backed security strips are defined, valued, and analyzed. Mortgage-backed security strips are compared with treasury security strips in concept, are found to behave much differently from treasury security strips under various interest-rate assumptions, primarily because of the implicit call option component embedded in mortgage-backed securities. The values, and sensitivities of values, of mortgage-backed security strips are investigated in detail under interest rate increases and decreases of 500 basis points from an assumed base interest rate. The value behavior of mortgage-backed security strips with alternative coupons is also analyzed. Finally, potential hedging uses of mortgage-backed security strips and policy concerns relating to the use of these instruments by thrift institutions are discussed.
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