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Course 205


TIGRs, CATS, and LIONs--no, you will not encounter them in The Wizard of Oz. You cannot find them in a zoo, either. These things with the catchy names are actually bonds. There are other animal-named bonds as well--dealers have sold RATs, COUGARs, GATORs, EAGLEs, and even DOGs. As an educated investor, you shouldn't be put off by the "cutesy" acronyms used by the brokerage community--after all, they are entitled to an inside joke. Instead, you should know what they are and how they might fit into your investment objectives.

What Are TIGRs, CATS, and LIONs?

TIGRs, CATS, and LIONs--actually referred to as "felines" by some--are acronyms for securities issued by private companies but derived from U.S. Treasury bonds. The catlike appellations are brand names belonging to the brokerage firms that first created them. For instance, Salomon Brothers invented CATS--Certificates of Accrual on Treasury Securities. Merrill Lynch introduced TIGRs (Treasury Income Growth Receipts), and Lehman Brothers created LIONs (Lehman Investment Opportunity Notes).

Introduced between 1982 and 1986, the felines are zero coupon instruments based on Treasury bonds the brokerages held in escrow. They were created through a process known as coupon stripping: the brokerage would separate—strip--the bond's interest (or coupon) from its principal, and issue bonds based on the interest separately.

Unlike regular bonds, CATS don't make regular payments of interest to their holders. Instead, investors buy them at a deep discount from their face value, which is the amount the investor receives when the bond matures. The difference between the face value and the actual price of the zero-coupon bond represents the interest earnings of the investment.

In 1986, the Treasury instituted its own STRIPS system for backing zero coupons with Treasury securities, one that made it easier for private firms to issue them and that was safer for investors. As a result, our menagerie of feline bonds is no longer being issued. However, they are still available on the secondary bond market.

Evolution of TIGRs, CATS, and LIONs

The investment firms that designed the "felines" in the mid-'80s did so by purchasing U.S. Treasury bonds and stripping the interest from the principal. The interest payments were then divided into units, which became the basis of zero-coupon bonds.

For example, a firm might purchase a 20-year Treasury bond, which it would place in escrow. It would then strip the interest from the principal and divide it up into 40 units based on the semi-annual interest payments of the Treasury bond.

It could then issue 40 zero-coupon bonds, each with a face value that equaled the interest payment on which it was based. The zeroes would be sold at deep discount: A 20-year bond that paid $1,000 at maturity might cost about $300.

These Treasury-backed zeros offered investors a financial instrument that had abundant supply, no default risk and, best of all, no chance of being called--paid off before maturity, reducing the investor's return.

Comforts of TIGRs, CATS, and LIONs

The popularity of zero-coupon bonds based on coupon-stripped Treasury securities led to a proliferation of animalesque brand names in the few years they were being created, and moved the Treasury to create a system to make issuing them safer for investors and easier for brokerage firms. The felines were popular because they allowed investors to participate in the earnings and safety of Treasury bonds without the expense and potential shortcomings.

Even though the feline bonds were issued by private firms, which ultimately had the obligation to repay them, the fact that they were backed by U.S. Treasury bonds gave them a relatively high degree of security. And that security could be yours at a price you could afford--a fraction of the tens of thousands of dollars needed to purchase Treasury bonds.

There was another degree of comfort added by the fact that the felines were zero coupons--they could never be called, meaning that you could count on your return if you held the bonds to maturity. (These bonds were noncallable for a period, but they may now be called.) But of course, you did not have to hold them to maturity. An active and volatile secondary market exists for Treasury-backed zeros, which is why those TIGRs, CATS, and LIONs that have not matured still stalk the bond markets today.

TIGRs, CATS, and LIONs Are a Twist on a Popular Kind of Bond

TIGRs, CATS, LIONs, and the rest of the menagerie of proprietary names that came out of the mid-1980s, were zero-coupon bonds based on the interest of U.S. Treasury securities. Brokerage firms held the Treasury bonds in escrow and issued new bonds based on their interest payments in a process known as coupon stripping. Though they are no longer issued, they are still traded on the secondary market, where they are prized for their low risk and reliable returns.

Quiz 205
There is only one correct answer to each question.

1 Coupon stripping consists of separating a bond's interest from its...
a. Principal
b. Coupon
c. Earnings
2 Compared with its face value, the issuing price of a zero coupon bond is...
a. Much higher
b. About the same
c. Much lower
3 The units that Treasury-backed zeros are based on represent...
a. Principal
b. Interest
c. Escrow
4 Which of the following is not a benefit of TIGRs, CATS, and LIONs?
a. Ownership of a Treasury security
b. Low default risk
c. Reliable returns
5 CATS were securities...
a. Issued by brokerage firms and based on Treasury bonds
b. Issued and sold by the U.S. Treasury
c. Issued by the U.S. Treasury and sold by brokerage firms
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