Tn10 transposition involves the formation of a hairpin intermediate at the transposon termini. Here we show that hairpin formation exhibits more stringent DNA sequence requirements at the terminal two base pairs than either transpososome assembly or first strand nicking. We also observe a significant DNA distortion at the terminal base pairs upon transpososome assembly by chemical nuclease footprinting. Interest ingly, mutations at these positions do not necessarily inhibit the formation of the distortion. However, it remains a possibility that the inhibitory effect of these mutations is due to a defect in protein–DNA interactions subsequent to this deformation. Terminal base pair mutations also inhibited strand transfer, providing evidence that transposase interactions with the terminal residues on both ‘transferred’ and ‘non-transferred’ strands are important for hairpin formation. We also demonstrate that mutation of a highly conserved tyrosine residue that is a component of the YREK motif, Y285, results in a phenotype comparable to that of the terminal base pair mutations. In contrast, a mutation at another conserved position, W265, is shown to relax the specificity of the hairpin formation reaction.