For investors, the main advantages and disadvantages of strip bonds and packages are outlined below. Investors should seek professional advice to determine if these apply to their situation.
Strip bonds
Advantages
- You know what the return on your investment will be if you hold it to maturity
- You know the amount that you will receive at maturity (except for indexed stripped bonds)
- You may be able to realize a capital gain, instead of interest income, if interest rates fall
- You may have possible tax savings by holding a series of strip bonds instead of a conventional bond from the same issuer that has the same cash flows
Disadvantages
- Because the market for strip bonds can be illiquid, you may not be able to sell them when you want to
- If you sell before maturity, you may have a capital loss, depending on market conditions at the time
- Tax laws may require that you pay taxes related to the hypothetical interest or gain each year, even if you did not receive an actual cash payment
- Because many strip bonds have a long time horizon, there could be unforeseen changes that adversely affect your investment (e.g., changes in tax laws, issuer credit rating, etc.)
Strip bond packages
Advantages
- Investment dealers can design packages to meet the needs of investors, so that the investor holds just one security instead of several strip bonds
- From a Canadian tax perspective, investors may realize some benefits in some circumstances
Disadvantages
- Because the market for strip bond packages is very illiquid, you may not be able to sell them when you want to
- If you sell before maturity, you may have a capital loss, depending on market conditions at the time
- Taxation of strip bond packages is much more complex than for conventional bonds or even strip bonds
- Tax laws may require that you pay taxes related to the hypothetical interest or gain each year, even if you did not receive an actual cash payment
- Because many strip bond packages have a long time horizon, there could be unforeseen changes that adversely affect your investment (e.g., changes in tax laws, issuer credit rating, etc.)
NextCopyright Keith Campbell ©2005. All rights reserved.