Bond Basics

[gregorj]

Respecting Canada Premium Bonds, these have terms and conditions that are specified in an Order in Council. The Order in Council states, among other things, what the issue and maturity dates are for a specific series. The recording of the bond is done by recording an entry in the Bond Register. Finally, the bond certificate is issued with the issue date and the maturity date displayed on the certificate.

For the Series 4 Premium Bond, Order in Council 1998-1460 (found through http://www.pco.gc.ca) specified an issue date of December 1, 1998, and a maturity date of December 1, 2008. In August 2008, The Minister of Finance announced Series 3 through 8 Premium bond maturity dates would be extended 10 years. This would change the maturity date from December 1, 2008, to December 1, 2018. In the Bank of Canada's 2008 annual report on bonds, Series 8 is not mentioned as being extended. I could also not find any Order in Council for the extension.

Respecting the Canada Premium Bond, Series 4 (a.k.a P4), some bonds were printed with maturity dates of November 1, 2008, rather than December 1, 2008. I redeemed mine on November 1, according the the bond certificate maturity date. My FI initially gave me my $5K (I redeemed 5 $1,000 bonds)and then retook it 3 months later on Jan 29, 2009. The Bank of Canada issued replacement bonds with the new extended maturity date of December 1, 2018. I cried foul with my FI and pointed to Section 36 and Section 7, subsection 2 of the Domestic Bonds of Canada Regulations as the replacements were not "of like tenor" to the originals (different maturity dates). Needless to say, I prevailed and got my money back by Feb 5, but how many others have not?

All this to ask: Which takes precedence when there is a conflict: the Order in Council, the record entry in the Bond Register or the date as stated on the bond?

Comments, anyone?

[Robillard]

gregorj,

I didn't want to give the impression that your question was not important. My gut feeling is that the order in council trumps the other two, but on this sort of question, I cannot even feign expertise. If anyone has a serious problem dealing with these sorts of conflicts (with lots of money at stake), it is probably better to consult a lawyer.

[gregorj]

Yup, a lawyer needs to be consulted for sure. I have no way of knowing how to go about finding such victims.

I have no idea whether the bond is superceded by an Order in Council.

Hopefully others who are victims of this will discover this post and post a comment.

[heyjude]

Great thread, thank you Robillard!

Can you explain Real Return Bonds?

[leslie]

RR Bond links:
http://www.bylo.org/rrbs.html
http://members.shaw.ca/retailinvestor/RRBond.xls

[Robillard]

heyjude,

While I have never purchased a real return bond, I do have an understanding how they work. Real return bonds are typically issued by governments; the format is not very popular with corporations.

Real return bonds come in two basic varieties. Ones for which the coupon varies over time, and ones for which the redemption value varies (increases) over time.

If the coupon payment varies, then the coupon payment is made up of two components: the index portion, and the spread portion. When the bond is first issued, the spread portion is fixed. The index portion resets at predetermined intervals. Most "real return" bonds use the inflation rate imputed by some form of the consumer price index. In this way, the bondholder is guaranteed a return on the coupons that cannot be eroded by inflation.

If the redemption value varies over time, then what typically happens is the redemption value (the repayment of principal at the maturity of the bond) is indexed to inflation. So if you buy this type of real return bond with a face value of $100, and inflation is 2% in the first year, then the redemption value will increase by 2% to $102. The redemption value keeps updating every year (or more frequently) until the bond matures. In this way, the redemption amount at maturity will have the same buying power that it had when the bond was purchased.

After they are issued, real return bonds can trade at a discount or premium, just like other bonds. Pricing a real return bond can be a bit tricky since the future payments are uncertain. The market prices of these securities has implications for investors. In particular, where a real return bond trades at a premium to a non-index-linked government bond with the same term to maturity, it generally implies that inflation is expected to be higher in future

[leslie]

I think the explanation on bylos's site is better. Canadian RR bonds have both principle and interest both indexed to CPI inflation.

[johnsazzr]

Timing is everything it seems when buying bonds, but I love them..about 60% of my RRSP is strip bonds, most provincially guaranteed...they will all be held until maturity ..my average yield to maturity on them is about 6.75%....they were all 10 yrs + to maturity when I bought them but the timing fits with my retirement goals (age 50-52)

[zylon]

Found this thread while doing a search for "bonds" and am bringing it forward, as there's a lot of good info here.

I recently purchased Telus Corp 3.65% 25May16 in my Practise account to give me some motivation to gain some understanding of bonds - I know nothing about them now.

I'm totally mystified as to why anyone would own bonds now; aren't bond prices guaranteed to go down when interest rates start moving up?

We're at the low end of the interest rate cycle; when will the cycle be near the top? - I don't know ... maybe 5, or 8, or 11 years hence? Enough time for me to do some learnin' now and get ready to buy bonds when interest rates are high.

[KaeJS]

I'm totally mystified as to why anyone would own bonds now; aren't bond prices guaranteed to go down when interest rates start moving up?

Buying bonds now at this very moment could be a bad idea, other than for diversification purposes.

Sure, bond prices look poised to drop, but yields will increase. When this happens, (should be soon) it would be a good time to purchase bonds because you will get the bond at a discounted price and the interest you receive will be higher. It will be good for buyers in the near future.

However, if you already own bonds (like you do in your practice account with Telus 3.65% 25May16) this will be bad for you. Why? Cause you've already got your interest coming in, but the bond prices are going to fall. So, if you're a seller, you're not going to be so happy. Your bond that is worth $1000 paying out 3.65%, is paying out the same 3.65%, but your bond is trading at a discount and is now worth only $950! So, if interest rates keep rising until May 25, 2016 and you want to sell before then.... you're going to take a hit on your bond price. Although, if you keep your bond all the way until May 25, 2016, you will receive your 3.65% the entire way and then receive the face value of the bond (what you paid for it originally) at the maturity date.

Basically, if you own bonds right now at this very moment, you should be ready to hold them until maturity, or else you will more than likely have to sell your bond at a discount.