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I'm looking into creating my own 10 year bond ladder with about a third of my 401k. I like the safety Treasury Notes, but I do not want to have semi-annual interest payments which are not be as cost effective to reinvest. So it looks like the best option are strips or zero coupon, which only pay once upon maturity.

In the WSJ I see that two types are offered, principal-only and interest-only (cupon-only). I see that for later maturity dates, such as, Feb 15, 2011 the cupon-only has a slightly higher yield of 5.36% vs 5.12% for the principal only.

My understanding is that both strips are packaged into $1000 face bonds and then discounted eg. 62% (cupon) and 63 11/32% (principal). Since yield is yield, there must be some other reason for the differential. If I understood the reason and it did not affect my goals, I'd prefer to take the higher yield. I've looked into various sources, but none has shed light on the difference.

Can TMF illuminate this topic?

Thanks a mint,
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