A conventional bond is a financial instrument that pays a set rate of interest each year in the form of two semi-annual interest coupons and whose face value, or principal is repayable at maturity. A Government of Canada or provincial government bond may be purchased by an investment firm, which will then physically remove the interest coupons from the bond and in doing so, create a series of individual notes with specific maturity dates commonly referred to as stripped bonds. Each coupon is then sold separately at a price that presents the present value of the future cash to be received.
There are several major advantages to investing in stripped bonds, or strips. Since there are no interim interest payments to be reinvested, the money is compounded at a fixed rate, providing a guaranteed yield to maturity and eliminating the need to reinvest small amounts of interest, possibly at lower rates. Strips can be used as short-term money market substitutes or long-term investments and are saleable at any time at current market prices. Strips can be purchased with staggered maturity dates to provide averaged yields over a period of years, giving an investor great flexibility in tailoring his or her investment strategy.
The rates used to price individual stripped bonds ensure that the yields will be competitive, and in some cases, greater than the corresponding maturities of the regular bonds. In addition to these factors, it should be remembered that the stripped coupons, like the bonds themselves, are backed by the full faith and credit of the government issuer.
Stripped bonds are best suited for use in Registered Accounts, where they can provide a guaranteed value for all or part of the funds at some date in the future, with the full advantage of tax-free compounding to assist in the growth. As previously mentioned, various maturity dates are available ranging in term from several months to 30 years.
If you believe stripped bonds should be part of your portfolio, contact your CIBC Wood Gundy Investment Advisor before making any investment decision.
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