The buyer of the bond receives the rate of return by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date.
These new securities are sold as zero-coupon bonds with maturities that correspond to the timing of each particular interest payment. For example, consider a seven-year Treasury note. The note consists of 14 interest payments and one principal payment due at maturity.
Treasury; rather, financial institutions create and sell them. Treasury does make the STRIPS program viable, however, by making the physical mechanics of detaching the interest and principal payments possible. Principal-only STRIPS can be excellent investments for investors who are especially wary of risk or need specific payments on specific future dates. They are also good for tax-deferred accounts such as IRAs.
But there are factors the investor should consider before investing. Thus, with their virtually guaranteed repayment , principal-only STRIPS make excellent defensive plays in an uncertain market.
Second, inflation takes a bigger bite out of principal-only STRIPS returns than from riskier but higher-yielding fixed-income securities. Thus, changes in inflation expectations or the degree of uncertainty about inflation can really affect principal-only STRIPS prices.
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Although you receive no tangible income, you typically still have to pay federal income tax on the bond's accretion for the year. The securities can be bought by private brokerages. The act of detaching the interest payments is called coupon stripping.
A conventional bond is one that makes regular interest payments to bondholders who receive repayment for their principal investment when the bond matures. If the bond is sold before it matures, a capital gain or loss may ensue. The face value of the bond is the amount received by the bondholder at maturity. If an investor wishes to sell prior to maturity, the market is very liquid. Personal Finance.
These coupons become separate securities, with the principal payment due at maturity, with no interim coupon payment. Assuming it originally pays coupons semi-annually, 21 zero-coupon bonds can be created. This includes the 20 semi-annual coupon payments.
There is also a bond created from the principal payment at maturity. All 21 securities are distinct and trade in the market. They have a very high credit quality since the bonds are backed by U. Treasury securities. If an investor wishes to sell prior to maturity, the market is very liquid.
Generally, taxes are due for the interest earned each year, even though there is no cash payment until maturity or when the STRIPS are sold. However, a tax-deferred account, such as an individual retirement account IRA and nontaxable accounts, which include pension funds , avoid this taxation.