What are STRIP Bonds?

Posted by Rebekkah On January - 14 - 2013 0 Comment

Government bonds were originally created in the late 1600s to cover government expenses and fund wars, paying back funds with a guarantee. They were considered risk free bonds because the government can add currency or increase taxes to redeem them, which gives a sense of security that the bond is effective no matter what happens. There are three types of government bonds–municipal bonds, treasury, and zero coupon bonds. Municipal bonds are used for daily expenses and building projects and treasury securities have a 10 year span for maturity. Zero coupon bonds will be explained below, as they are directly related to strip bonds.

A strip bond is the result of taking a government bond and dividing it into its principle part and its interest rate part. They were created by bond dealers who had an idea that stripping a coupon off of an existing bond would guarantee the same advantages of municipal bonds to individuals who wanted the long term benefit at a discounted price. The discount varies to this day, depending on the credit rating of the person buying them. It is especially targeted to people who do not need an income at the time of purchase, but would like to receive the bond’s value in the future. Once it is separate, the principal strip bond becomes a zero coupon bond. Zero coupon bonds can be called zero, discount or deep discount bonds. It requires no interest rate throughout its duration and people who invest in zero coupon bonds get the benefit of planning a long term goal since the bond itself does not mature between ten or more years. Zero coupon bonds became more common in the 1960s because of its flexibility. Individuals who bought them were able to customize them. The bond was once a physical coupon, then it became receipts, and then electronic.

Strip bonds benefit the investor because it is a more secure method of investing; its cash flow value is high and the maturity dates on which the money is accessible is specified to the investor. Another advantage of strip bonds is that the owner will know what their return will be based on the yield percentage, which is a sum the investor can expect back by the time it matures. It is usually calculated as the difference of the maturity value and the price. The owner will gain back that percent each year until it reaches maturity. Strip bonds are commonly bought in Canada and the United States, Canada being the country to issue the highest amount at about 4,000. But they are available in other countries such as Japan, the United Kingdom, and France. France was one of the first countries to adapt its use.

Strip bonds are one of the most popular independent investments because of its potential for growth even at times when interest rates fall. It also presents opportunities for trading from time to time as interest rates fluctuate. The maturity value of strip bonds are never affected by those fluctuations. Even though the maturity time span generally reaches about 15 years, it is possible for investors to raise it up to 30 years.

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This article was written and provided to eFinancial Resource Center by one of our partners, Donald Turner. Donald is an online writer of finance articles throughout the web. He writes this on behalf of Kanetix, a top insurance provider. If you’re looking for travel coverage or other financial services, make sure to check them out.

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