Bonds are available at banks, trust companies, credit unions, brokerage house, and licensed financial advisors.
Generally, there is no commision when you purchase a bond, becasue the commision is already factored in the bond price you will obtain.
Bonds
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What is Bonds?
Elements of Bonds
Types of Bonds
Pricing of Bonds
Rating of Bonds
Taxation of Bonds
How to invest in Bonds?
==========================================================================================================
What is Bonds?
Elements of Bonds
Types of Bonds
Pricing of Bonds
Rating of Bonds
Taxation of Bonds
How to invest in Bonds?
==========================================================================================================
What is Bonds?
Bond is a fixed-income security which pays a regular series of cash flow (interest payments on bond), at a stated rate (coupon rate), for a certain period of time (materity date). Government and corporations issue bonds to borrow funds from investors to finance their deficits or operations. Investors lend their money to government or corporations by purchasing bonds, in return, they receive interest payments.
Elements of Bonds
(a) Face value: The amount that shows on the face of the bond is called face value, or bond denomination. It is usually at $1,000 or $10,000.
(b) Coupon: It is the stated payment of bond, usually paid twice a year at 6-month intervals. The lower coupon will accompany with higher bond volatility.
(b) Yield: It is the required rate of return for bonds. If the bond yield goes up, the bond price will drop because the expected future cash flow will go down. So the price and yield will always move in opposite direction. There are three types of bond yield curve:
Normal yield curve: when long-term interest rates are higher than short-term interest rates. (2-year bond paying 6% and 10-year bond paying 8%). This is the normal situation.
Steep yield curve: when difference between long-term and short-term interest rates is large. (2-year bond paying 6% and 10-year bond paying 15%).
Short-term rate maybe sharply reduced by government.
Inverted yield curve: when short-term interest rates are higher than long-term interest rates. (2-year bond paying 6% and 10-year bond paying 5%). Investors anticipate the long-term rate will drop.
(c) Interest rate: Bond has an inverse relationship with interest rate. It means when interest rate goes up, bond price will fall; and vice versa.
(d) Term to maturity: The longer maturity of the bonds, the higher its volatility.
Types of Bonds - Bonds can be classified into different ways based on various criteria.
Types of Bonds based on their issuers |
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Government Bonds |
Treasury Bills: short-term government bond that trade at discount and mature at par. Offered in denomiations as low as $1000, high yield than CSB and GIC. Sold at discount, no interest payment, but tax as income. Canada Savings Bond: Specific government bonds that cannot be trade, only kept or cashed in. Sold through financial institutions or employer plan. |
Provincial government Bonds |
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Municipal government Bonds and Debentures |
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Other types of Bonds |
Corporate bonds Mortgage bonds Real Estate bonds Strip Bonds (zero coupon bonds): This type of bond pays no interest payments, and can be purchased at a deep discount.It is a better choice than GIC, with higher interest and more liquidity Preferred securities |
Types of Bonds based on their valuation |
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Discount Bond |
Bond sell above its par value (e.g. bond selling at $1080 over its par value $1000) current yield (interest rate) > coupon rate |
Premium Bond |
Bond sell under its par value (e.g. bond selling at $980 over its par value $1000) current yield (interest rate) < coupon rate |
Par Bond |
current yield (interest rate) = coupon rate |
Pricing of Bonds
Bonds are quoted with an index which base value is 100. A bond trading at 100 is called trading at face value, or at par. If a bond is trading below 100, it is a discount bond. Bond selling at 98 is called trading at 98% of par. On the other hand, if a bond is trading higher than 100, it is a premium bond.
The price of the bond is determined by two components:
(1) The present value (PV) of a series of future coupon payments;
(2) The present value (PV) of the bond's principal
Bond price = PV(coupon payment) + PV(bond's principal at maturity)
Rating of Bonds
Bond rating is a means to measure the quality of bonds. It offers investors an independent and objective assessment on the credits of the issuing companies, as well as the risks of their investment.
Bond rating agencies in Canada:
Dominion Bond Rating Service
Canadian Bond Rating Service (S&P)
Bond rating agencies in US:
Moody's
Standard & Poor's
Taxation of Bonds
Interest payments earned from bonds are treated as interest income, and taxed at investor's marginal tax rate.
Compare to stock dividends and capital gains, there is no tax advantage.
How to invest in Bonds?