All you need to know about bonds

A bond is a type of debt security issued by governments, corporations, or other entities to raise funds for various projects or operations.

When you buy a bond, you are essentially lending money to the issuer in exchange for interest payments over a specific time period, also known as the bond's term.

Get familiar with these important terms to better understand bonds:

• Face value / Principal - The amount of the loan represented by the bond.
  • Please note that this is not necessarily how much the bond will cost to purchase.
  • Bonds usually have a principal of either $100 or $1,000 each.
• Coupon rate - The annual rate of interest paid out on the bond.
  • This is often (but not always) a fixed percentage.
  • For example: a $1,000 bond with a 5% coupon rate will pay out $50 per year.
• Coupon date/frequency - At what date (and how often) the interest is paid
• Maturity date - When the issuer is to pay out the full face value (principal) to the bondholder.
  • Bonds can have short-term (1-3 years), medium-term (4-10 years), or long-term (10+ years) maturities.
• Price - The current market value of the bond, which may be trading at, above, or below par (100).
  • The value of a bond can be influenced by many factors including market conditions, interest rates, and the creditworthiness of the issuer.
  • When a bond trades higher than par (face value), this is typically because the coupon (interest) rate of the bond is higher than prevailing central bank interest rates.
  • When a bond trades below par, this is usually because the coupon rate is lower than current interest rates, or the issuer’s credit rating has deteriorated.
• Yield - The effective annual return on a bond investment, taking into account the bond’s price, coupon rate, and time to maturity.
  • The most common measure of yield is yield to maturity (YTM) which helps estimate the total return an investor can expect if they hold the bond until it matures.
  • Yield helps investors compare bonds with different maturities, coupon rates, and prices, and assess the attractiveness of a bond investment relative to current market conditions and interest rates.
• Credit Rating - A rating given to corporate bonds that reflects the creditworthiness of a bond issuer. You can think of it like a “credit score for a corporation”.
  • Credit rating agencies such as Standard & Poor's, Moody's, Fitch, and DBRS assign these ratings based on their analysis of the issuer's financial strength, stability, and overall economic conditions.
  • Ratings range from 'AAA' (or equivalent) for the highest-quality bonds with the lowest default risk to 'D' (or equivalent) for bonds in default or with a high likelihood of default.
  • A higher credit rating generally means a lower interest rate, as investors perceive lower risk and require less compensation for investing in the bond. On the other hand, a lower credit rating signifies higher risk and results in higher interest rates to attract investors.

Company XYZ has big plans to set up new manufacturing facilities in South America. To make this dream a reality, they need to raise $4 billion. After weighing their options, XYZ decides the best way to get the funds is by issuing bonds with a 4% annual interest rate for the 15-year life of the bond.

Working with an investment bank, XYZ Ltd. offers 4,000,000 bonds at $1,000 (face value) each. This helps them gather the $4 billion they need. [$1000 (face value) x 4,000,000 (bonds)]

Betty is an investor who's excited about XYZ's plans and decides to invest $20,000 into their bond. As long as XYZ Ltd. doesn’t default on their loan, Betty will enjoy $800 in interest payments every year for the next 15 years. [$20,000 (amount invested) x 4% (interest rate)]

Once the 15-year term ends and the bond reaches its maturity date, Betty will also get her initial $20,000 investment back from the issuer, ending the contract and bond obligations.

There are several types of bonds that Canadian investors can choose from, each with their own unique characteristics and risk-return profiles. Let's explore the main categories:

Government Bonds

These bonds are issued by the federal or provincial governments to fund public projects or manage their debt. They are considered low-risk investments, as they are backed by the credit and stability of the issuing government.

Examples include: Province of Ontario bonds, Province of Alberta bonds, and etc.

Municipal Bonds

Issued by cities, towns, or other local government entities, municipal bonds finance various projects like roads, schools, and hospitals. Municipal bonds are generally considered low-risk investments, though they may have slightly higher risk than federal or provincial bonds.

Examples include: City of Vancouver bonds, Regional Municipality of Peel bonds, and etc.

Corporate Bonds

Companies issue corporate bonds to raise funds for their operations or specific projects. Corporate bonds generally offer higher returns than government bonds, but they come with increased risk due to the possibility of the issuing company defaulting on its debt.

Investment-grade bonds have higher credit ratings, while high-yield or junk bonds have lower ratings and higher risk.

Examples of corporate bonds include: Bell Canada bonds, Enbridge bonds, and etc.

At Questrade, bonds and other fixed income securities can be bought online.

There are multiple ways to buy bonds and GICs through the trading platforms.

If you have Edge Web added:

Choose Accounts > Questrade Edge Web > Fixed income

Keep these important things in mind when considering bonds:

1. Know your goal: Determine your investment objectives, such as income generation or capital preservation, before diving into bond trading.
2. Research the issuer: Investigate the financial health and creditworthiness of the bond issuer to gauge their ability to repay the debt.
3. Understand bond types: Familiarize yourself with various bond types, like government, corporate, or municipal bonds, as they come with different risks and rewards.
4. Check credit ratings: Review the bond's credit rating to assess the issuer's default risk and overall financial stability.
5. Consider interest rates: Keep an eye on interest rates, as they inversely affect bond prices, with prices falling when interest rates rise and vice versa.
6. Diversify your portfolio: Spread your investments across different bond types, industries, and maturities to reduce risk.
7. Evaluate liquidity: Consider the liquidity of the bond, or how easily it can be bought or sold in the market, as this can impact your ability to sell the bond when desired.
8. Monitor market conditions: Stay informed about economic trends and market developments, as they can influence bond prices and performance.

Note: The information in this blog is for educational purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade, Inc., its affiliates or any other person to its accuracy.