Smart Bond Investing—Types of Bonds

TIPS and STRIPS

 

TIPS

 

If you are concerned about inflation, the U.S. Treasury Department has some bonds that might interest you. They're called Treasury Inflation Protected Securities, or TIPS. Issued with maturities of five, 10 and 30 years, TIPS shelter you from inflation risk because their principal is adjusted semiannually for inflation based on changes in the Consumer Price Index-Urban Consumers (CPI-U), a widely used measure of inflation. Interest payments are calculated on the inflated principal. So, if inflation occurs throughout the life of the bond, interest payments will increase. At maturity, if the adjusted principal is greater than the face or par value, you will receive the greater value.

 

Because they are U.S. Treasury securities, TIPS are backed by the "full faith and credit" of the U.S. government and, therefore, carry virtually no credit or default risk. Remember the trade-off between risk and reward? It holds for TIPS as well. While the TIPS investor is sheltered from inflation risk and, in fact, benefits during periods of inflation, the trade-off is that the base interest rate on TIPS is usually lower than that of other Treasuries with similar maturities. In periods of deflation, low inflation or no inflation, a conventional Treasury bond can be the better-performing investment.

 

You might ask, "What happens if deflation (a negative inflation rate) occurs? Would my TIP investment be worth less than what I paid for it?" No, unless you paid more than the face value of the bond. Upon maturity, the Treasury Department agrees to pay the initial face value of the bond or the inflation-adjusted face value, whichever is greater.

 

TIPS Risk Report Card   Interest rate risk: If interest rates rise, the value of your bond on the secondary market will likely fall.   No inflation risk, because principal is adjusted semiannually for inflation based on CPI-U.   No call risk and virtually no liquidity, event or credit and default risk.   Opportunity risk: In periods of no or low inflation, other investments, including other Treasury bonds, may perform better.

 

For more information on TIPS, see the TreasuryDirect^® Treasury TIPS Web page.

 

TIPS Snapshot   Issuer U.S. Treasury   Minimum Investment $100   Interest Payment Semiannually   How to Buy/Sell At original issue through TreasuryDirect or broker. On the secondary market through a broker.   Bond Interest Rate Tied to Consumer Price Index. Rate information at TreasuryDirect website or through a broker.   Price Information TreasuryDirect for original issues. Broker data vendors for secondary trade data.   Website for More Info TreasuryDirect's TIPS Web page

 

STRIPS

 

STRIPS is the acronym for Separate Trading of Registered Interest and Principal of Securities. The STRIPS program lets investors hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities. STRIPS can only be bought and sold through a financial institution or brokerage firm (not through TreasuryDirect), and held in the commercial book-entry system.

 

STRIPS Risk Report Card   No call risk and virtually no liquidity risk, event risk or credit and default risk.   Interest rate risk: If interest rates rise, the value of your STRIP on the secondary market will likely fall.   Inflation risk: STRIP yields may not keep up with inflation.

 

STRIPS Snapshot   Issuer Financial institutions, government securities broker-dealers   Minimum Investment $100   Interest Payment Non-interest bearing: Pays out at maturity   How to Buy/Sell At original issue and on the secondary market through a broker. U.S. Treasury does not sell STRIPS to investors.   Bond Interest Rate Determined at origination and varies by bond. Ask your broker for the rate of individual STRIPS.   Price Information Broker: Quotes are disseminated and traded over-the-counter. No automated quotation service available.   Website for More Info TreasuryDirect's STRIPS Web page