Strips and mortgage-backed securities

by Natalie MacLellan on July 27, 2010

in Types of Investments

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Continuing our Investments at a Glance summer series, today we look at more fixed income securities: stripped bonds and mortgage-backed securities.

As discussed in the previous post, there are two parts to a bond: the principal or value of the bond, and the interest. With stripped bonds (strips) the interest payment coupons and the principal portion of a bond have been separated from each other, and are sold as individual investments. Terms typically range from 18 months to 30 years.

Strips are sold at a discount and mature at face value. The difference is your interest income. The longer the term to maturity, the deeper the discount.

So, for example, I may buy the principal portion of a bond, paying $10,000 for a $11,000 bond. The $1000 is my interest income, giving me a 10% yield.

Strips generally have higher yields than regular bonds with similar terms and credit quality. Because the income you earn is deferred, you should seek tax advice before investing in strips outside a registered plan like a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF) or Registered Education Savings Plan (RESP).

When you buy mortgage-backed securities (MBS), you are buying an ownership interest in a pool of mortgages. Terms typically range from one year to 10 years.

MBS offer fixed rates of return and usually make monthly income payments. The monthly payments are made up of a share of the interest and principal payments associated with the mortgages.

MBS are fully guaranteed by the Canadian Mortgage and Housing Corporation (CMHC).

This has been the sixth post in our Investments at a Glance series. Next time, we begin to look at equity investments.

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