Bonds 101
Before we get into Strip Bonds, we will talk about Bonds. There are many types of bonds to invest in. Bonds are a form of debt. They are loans, and you serve as the bank. So you loan your money to and they promise to pay you back in full, with interest. A city may sell bonds to raise money for a bridge. Investors flock to safe bonds, and the income they regularly generate. But not all stocks are risk-free. In fact, many are very risky.
Strip Bonds 101
Strip bonds are only one of the many. Choosing the right bond depends on your financial situation. This also depends on the type of risk you are willing to put forth. There are treasury bonds, government bonds, high yield, foreign, government, mortgage, municipal, and the list goes on and on. This is then returned to the investor’s principal amount at maturity. These ‘Separate Trading of Registered Interest and Principal Securities’ – know as “STRIPS”. They were manually stripping the paper coupons from bearer bonds and selling them.
Financial Benefits of Strip Bonds
From an investment standpoint, there are various financial benefits of strip bonds. For starters, they are excellent investments for their production of compound growth over a particular time period. The returns are locked in at the time of buying and are held through maturity (Learn2succeed.com Inc., 2012).
There are no interim interest payments to be reinvested, so the amount is compounded at a fixed rate. This provides a guaranteed yield to maturity. This also eliminates the need to continuously re-invest small amounts if interest. Relatively small amounts of capital can generate significant maturity payouts.
Strip bonds can be bought with staggered dates of maturity for purposes of providing returns that have been averaged over a period of several years. This provides a great degree of flexibility in amending his or her strategy of investment. Strip bonds are substitutes for long-term investments. Investors can sell at any time, at the prices being offered.
Pricing of individual stripped bonds makes them competitive. In other cases, the rates can even be greater than the corresponding maturities of regular bonds.
Financial Risks of Strip Bonds
Strip bonds also suffer from significant financial risks. There are no interest payments before the bond matures. It is not practical and advisable for those that require a regular income (Whipp, n.d).
There are also wide fluctuations of the value of the bond in the prevailing rates of the interests due to the unavailability of regular payments for stabilizing the value (Learn2succeed.com Inc., 2012). Individuals accrue significant financial risks that sell the strip bonds before they mature. Therefore, it is often time hard to sell the bonds at all.
Investors selling strip bonds will have a disadvantage if they haven’t matured. They will have to pay taxes on the Original issue discount (OID). Also, one should consider the risk that the rate of inflation may be greater than the interest rate accrued by the strip bond. This would imply that the investment is not keeping up with the cost and standards of living.
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