Intro to Bonds

Bonds 101 When large organizations (companies or governments) need to raise large amounts of capital – they often turn to Bonds. Bonds are debt instruments that provide a fixed payment based on the stated interest rate.

A Simple Example John buys a $1500 bond with a 7% coupon (interest rate). He holds the bond until maturity (10 years). How much money will he earn? Answer: Each year, John gets $1500 x 0.07 = $105 Over 10 years, this is $1050. At the end of the 10 years, he also gets his $1500 back.

Some Bond Vocabulary 1.Face Value, Principal – the amount you initially loaned to the issuer. 2.Coupon – otherwise known as the interest rate 3.Maturity Date- the date on which you get your principal back. 4.Issuer – the person, company or authority that sells the bond.

An Example Louise buys a 5-year $2000 Canadian Corporate Bond which has an interest rate of 1.5%. a)What is the coupon rate? b)What is the maturity date? c)What is the principal amount? d)How much interest will Louise earn each year?

An Example - Answers Louise buys a 5-year $2000 Canadian Corporate Bond which has an interest rate of 1.5%. a)What is the coupon rate? 1.5% b)What is the maturity date? 5 years from now c)What is the principal amount? $2000 d)How much interest will Louise earn each year? (0.015 x 2000 = $30)

Debt vs. Equity With stocks, shareholders buy a share of the company. They become part owners and have voting rights and can receive dividends. Bonds are considered debt. The company/government owes you your money back, plus some interest. The bond holder is not a shareholder, but a creditor. Bonds Explained

To Be a Creditor…or not? Advantages of being a creditor: In case of bankruptcy, you will get paid out first before shareholders. You know exactly what you will receive from the bond. Disadvantages of being a creditor: You will not get to share in the company’s profits – you will only get principal + interest.

Bond Classifications There are generally 3 types of fixed-income securities that are classified by the length of time before maturity. **Remember, these are only guidelines ** 1.Bills: Maturity of less than one year 2.Notes: Maturity of 1-10 years 3.Bonds: Maturity of 10 years +

Government of Canada Bonds Log on to the Government of Canada website and do some research about the types of bonds offered in Canada. Types of Canadian Bonds Find out what current rates of return look like by searching the Bank of Canada website Bank of Canada Bond Rates

Types of Bonds Government Bonds: All debt issued by the Canadian Government is deemed safe. The government can always raise money through taxes to pay debt obligations. Municipal Bonds: Still considered relatively safe – cities don’t go bankrupt often (that’s what Detroit said!)

Types of Bonds – Cont’d Corporate Bonds: Bonds issued by corporations. They can be short-term (less than 5 years, intermediate (5-12 years) or long-term (over 12 years). They have higher yields because they are considered riskier. The company’s credit quality is an important consideration.

Who Should Hold Bonds in their Portfolio? Think about why we might want to hold bonds in our portfolios. Do some research online – how much should we hold? Use the RBC investor site as a starting point: Who Should Buy Bonds