Price volatility
The price of strip bonds generally increases over time, since they are discount instruments, eventually reaching the face value or maturity amount.
However, between the time that you buy the strip bond and the maturity date, there can be large swings in the price of the strip bond. If the interest rates go up, the value of a strip bond will go down. If rates go down, the price of a strip bond will go up.
If the rates go above the yield at the time of purchase, the market value of a strip bond investment may be below the price that you paid. The amount of the loss will depend on two factors:
- the amount of time since you made the purchase, and
- the difference between current yield and the yield at the time of your purchase.
These are the same kind of changes that you would see if you held a normal bond. However, because a strip bond does not make periodic interest payments, the change in the price will be much greater (i.e., more volatile) when expressed as a percentage of the value, if compared to the price change for a conventional interest-bearing bond for the same issuer having the same maturity date.
The amount of the difference depends on the interest rate of the bond and the amount of time remaining until the maturity date. The price of a bond (or strip bond) will be more sensitive to changes in interest rates if
- the time left to the maturity date is long and/or
- the interest rate paid is low.
This difference is due to the opportunity to reinvest the periodic interest payments until the final maturity date.
The tables below show some hypothetical examples of the potential price changes that can occur. The examples were taken from the Investment Dealers Association of Canada's "Strip Bonds and Strip Bond Packages Information Statement", dated April 1998. (The current version of this document is available on the IDA web site.)
Note that these examples assume that the change occurs quickly. If the change occurred over a longer period of time, the price changes, particularly for the strip bonds, may be partially offset by the amount of interest accrued since the date of the first price.
Maturing in 5 years
| Bond: | Strip bond | Bond paying 6% semi-annually |
|---|---|---|
| Market price (per $100 face value): | $74.41 | $100.00 |
| Yield: | 6.00% | 6.00% |
| Price with rate drop to 5%: | $78.12 | $104.38 |
| % price change: | +4.99% | +4.38% |
| Price with rate increase to 7%: | $70.89 | $95.84 |
| % Price change: | -4.73% | -4.16% |
Maturing in 20 years
| Bond: | Strip bond | Bond paying 6% semi-annually |
|---|---|---|
| Market price (per $100 face value): | $30.66 | $100.00 |
| Yield: | 6.00% | 6.00% |
| Price with rate drop to 5%: | $37.24 | $112.55 |
| % price change: | +21.49% | +12.55% |
| Price with rate increase to 7%: | $25.26 | $89.32 |
| % Price change: | -17.61% | -10.68% |
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