Bonds and Strip Bonds
Bonds
Bonds are securities representing indebtedness where the
issuer promises to pay the holder a specified amount of interest
for a specified length of time, and to repay the principal
amount of the loan at its maturity. Bonds can be issued by
Federal and Provincial Governments, utilities and corporations.
Strip Bonds
A strip bond - often referred to as a "strip" - is a fixed-
income product that pays no interest throughout its term,
and entitles the holder to the full face value at maturity.
Strip bonds are purchased at a discount and mature at par,
similar to a T-Bill. The interest earned is the difference
between the discount purchase price and the maturity value.
Also known as strips, strip bonds are created from conventional
Federal, Provincial, Municipal and Corporate bonds. Each
interest payment and the remaining principal amount are physically
separated, and sold as individual securities (referred to
as "coupons" and "residual" respectively). Each coupon and
residual is individually priced at a discount to maturity
value. For example, an eight-year strip yielding 5% would
have a price of $67.68, and mature at $100. Generally speaking,
the longer the term, the lower the price and the greater
the yield.
Due to the magic of compound interest, the increase in the
value of a strip can be substantial over time. A strip that
yields 7% will double in value in just over 10 years.
In a registered account, a strip can compound on a tax-deferred
basis. Because the maturity value is known, they can be matched
to a future known expense, such as a withdrawal from a child's
RESP, or to provide a predictable income stream within RIF
accounts.
For example, assume an investor, like you, wants to have
$50,000 available in 15 years for education or your retirement
needs. At a yield of 7%, an investment of only $18,122.30
would be required today.
Bond and strips held outside registered plans are subject
to annual taxation as if interest had been received, even
though no income is actually paid until maturity. You may
want to consult a tax specialist before purchasing in a non-
registered plan, as the taxation of this security is complex.
Strip bonds have become the most popular fixed -income investment
within registered plans - and for good reasons. Here's how
you can benefit from having strips in your portfolio:
Attractive Yields: Strip bonds typically
offer higher yields over conventional bonds of the same issuer,
term and credit rating. Strips generally offer better yields
over GICs and T-Bills as well.
Quality: Most coupons and residuals are
stripped from Government of Canada or Provincial bonds, and
represent a direct government obligation. High-quality Corporate
Strips are also available.
Guaranteed Yield: Strips offer true yields,
unlike conventional bonds. Strips are purchased at a discount
and mature at par, so there are no interest payments to re-invest,
at unknown yields. If held to maturity, your investment will
compound at the stated yield to maturity.
Liquidity: Strips are traded in an active
secondary market, are highly marketable, and can be sold
at any time at prevailing market rates.
Convenience: Strips are extremely low maintenance.
Once you have purchased them, you can virtually forget about
them until they mature and there is no need to worry about
re-investing interest payments every six months.
$1 Multiples: Unlike conventional bonds
that trade in $1000 increments, strip bonds allow you to
get every available dollar working for you (above the minimum
investment). Strips can be purchased in $1 Multiples (above
the minimum investment), meaning you can purchase $5437 face
value if you wish.
No Accrued Interest: Since there are no
interest payments with strips, you do not have to pay the
seller any accrued interest when you purchase.
Flexibility: Terms can range anywhere from
one month to 50 years. This can allow you to ladder your
strips (i.e. staggered maturities) to minimize your reinvestment
risk or strategically time your cash flows.
Are strip bonds for you?
Strips are more volatile in price than conventional bonds
of the same term and credit rating since no interest is paid
throughout the life of the product. Also, changes in the
general level of interest rates or issuer credit quality
will affect strip prices more than interest-bearing bonds - in
both directions. For investors who plan to hold the asset
until maturity, this should be of little concern, as the
strip will mature at par.
Take Action: For more information on strip
bonds, visit the strip bond link located under the Fixed
Income Detailed Product Search in RBC Direct Investing Online Investing.
View our extensive inventory today to find an issue that
meets your investment needs.
Open a RBC Direct Investing account now.
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