Evolution of TIGRs, CATS, and LIONs

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Evolution of TIGRs, CATS, and LIONs

The investment firms that designed the "felines" in the mid-’80s did so by purchasing US 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.

Here’s an example of how it worked

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.