Bond Basics

[Jungle]

Depends what bonds you are talking about. Popular standards are usually the 5 year Canada Bonds or DEX universe bond index. (Common for mutual funds and ETFs to track, mortgage rates) Lately, the yields and prices have been going up and down like a yoyo, so you have to watch the bond prices. I use the ETF XBB to watch prices.

TELUS is a corporate bond. Cooperate bonds are rated just like Government bonds. The more risky the bond, the higher the coupon should be.

I've always like some of the junk bond etfs. The group a pile of the risky cooperate bonds, so it kind of spreads the risk. The yields are usually around 6-7% and the unit price tends to track equity movement.

Right now Greece bonds are paying around 15% yield, but there is a high risk they could default and you lose all your money.

[KaeJS]

Right now Greece bonds are paying around 15% yield, but there is a high risk they could default and you lose all your money.

Thats not even worth it, IMO.

15% to take your chances on Greece, an already dying economy receiving aid packages.

Hm.. the 6-7% looks better.

[zylon]

First lesson learned: save a screen shot of the bond detailed quote when buying. I can't find the quote now, probably because that particular bond is no longer in my broker's available inventory.

... 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. ...

Thanks KaeJS ... you know a thing or two about bonds.

So let's see if I have this right.
My "practise" purchase was for $5,000 on June 22, 2011 which cost me $5,127.90 (2.6% premium).
Maturity date is May 25, 2016. Yield is 3.65%

If I hold the bond to maturity, my income will be:
2011    $ 96.00 (approx 192 days)
2012     182.50 ($5,000 @ 3.65%)
2013     182.50
2014     182.50
2015     182.50
2016      72.00 (approx 144 days)
        $898.00 total income - taxed annually as interest

On the maturity date I receive back $5,000
- with a result of $127.90 capital loss.

Added:
After doing a bit more reading, I need to make a correction.

As noted above, my transaction cost was $5,127.90 but the premium was actually 2.23% which means the bond cost was $5,111.50

The difference of $16.40 is due to the fact that I had to pay the accrued interest from May 25 to June 22 (about $0.50 per day).

To avoid paying this accrued interest, one would try to buy the bond soon as possible after the interest paid date. Most commonly, interest is paid every 6 months, although this may be different with other bond issues.

[KaeJS]

That's correct, so your total would be $770.10 for a gain.

Your yield on the $5127.90 would be 3.558962% (because when prices go up, yields drop. So what you did here is paid more to get less, which is okay.)

And yes, you paid a 2.558% premium on that bond.

[KaeJS]

So, for 4.92054795 years, or 1,796 days, you will receive 15.0178436%

Which, if I did everything properly...

Is a steady 3.05206731% per annum, not compounded.

[zylon]

Thanks again

It's not so complicated after all.

I had a mental block concerning bonds because years ago I heard Deirdre McMurdy say, - I don't understand bonds ... they're too complicated.

And I thought that if Deirdre can't understand bonds, and I consider her to be a fairly bright lady, then chances are I wouldn't get them either.

I know there's a lot more to bonds than what I studied today, but at least I'm getting the hang of the terminology.

[investorgirl]

...

If you purchase a bond between coupon payment dates, you will also have to pay for the accrued interest on the bond. Coupon payments are accrued daily until they are paid out on the specified payment date(s). The amount of accrued interest on the bond can be determined mathematically by taking the coupon payment amount, dividing it by the number of days that it accrues (for a bond with 2 coupon payments per year, this should be about 182.5 days) and multiplying by the number of days since the last payment. So for example, if you want to purchase $5000 in face value of bonds that pay 5% in coupons twice a year, and the bond is currently offered at 102, then you have to pay between $5100 and $5225 depending upon when the last coupon payment was made.

Selling a bond (prior to maturity) has a similar mechanic to purchasing a bond. If you tell your investment advisor you want to sell your bonds, they will call the bond trading desk, which will quote a bid price and yield. Using the example above, suppose you bought the bond quoted at 102 for about $5100 (on day after the last the coupon payment date). 9 months have passed, and you received one coupon payment of $125 in the interim. bond yields fell during this time and now your investment advisor says that the bond is being bid at 104. In this situation, when you sell the bond, you receive $5200 plus the amount of accrued interest (which should be about $62.50). The difference in prices of $100 is taxable as a capital gain, while the $125 coupon payment and $62.50 accrued interest are taxable as interest income.

Robillard,

Thank you for your succinct and easy-to-follow primer on bonds. So helpful!

I have a few, all in the form of convertible debentures. The last purchase was on the bond desk (as opposed to the offering) and I paid some accrued interest. I understand your math and using it as an example for my question (which follows):

FACE VALUE	PRICE at BUY	PRICE PAID	INTEREST ACCRUED (PAID)
5000	102	$5000 × 102% = $5100	$5000 × 5% × days (where days is 10/365) = $6.85
FACE VALUE	PRICE AT SELL	PRICE RECEIVED	ACCRUED INTEREST (RECD)
5000	104	$5000 × 104% = $5200	$5000 × 5% × days (where days is 45/365) = $30.82
			+ Coupon Payment = $125
			Total Interest Received = $155.82

My question is (and I'm hoping you can save me hours on end on hold with the CRA here) ― do you know how the interest paid on the BUY, $6.82, is treated? The way I see it, it can go one of three ways:

• be included in the ACB (lowering the capital gain, and therefore, resulting in an overall higher tax bill on the transaction, albeit negligible for most of us),
  
  
  Although I'm tempted to automatically dismiss this as a possibility (common sense wants to step in)... according to the 2011 CRA T5008 Guide:
  
  

  Box 20: Cost or book value is defined as "...the initial outlay or price paid by the investor for a security or debt investment."

• is considered an allowable expense on line 221, Carrying Charges and Interest Expenses (although it is not identified, neither as allowable nor not), or

• what I believe to be the most likely... as an offset against interest earned, such that in my example, taxable income would be $148.97 ($155.82 less $6.85).

I would be appreciative of your experience and response!

Thanks,

Denise

[investorgirl]

...

My question is (and I'm hoping you can save me hours on end on hold with the CRA here) ― do you know how the interest paid on the BUY [of a bond] is treated? The way I see it, it can go one of three ways:

• be included in the ACB (lowering the capital gain, and therefore, resulting in an overall higher tax bill on the transaction, albeit negligible for most of us),
  
  
  Although I'm tempted to automatically dismiss this as a possibility (common sense wants to step in)... according to the 2011 CRA T5008 Guide:
  
  

  Box 20: Cost or book value is defined as "...the initial outlay or price paid by the investor for a security or debt investment."

• is considered an allowable expense on line 221, Carrying Charges and Interest Expenses (although it is not identified, neither as allowable nor not), or

• what I believe to be the most likely... as an offset against interest earned, such that in my example, taxable income would be $148.97 ($155.82 less $6.85).

...

If anyone had the same question:

I heard back from the CRA and the response I received was that accrued interest paid with the purchase of a bond is included in the ACB; of course, this means that this results in a lower capital gain and increases interest income.

pro ― deferral of tax
con ― higher net tax (all other things being equal)

And there you have it!

Happy investing!

Denise (aka Investorgirl)

[caricole]

If anyone had the same question:

I heard back from the CRA and the response I received was that accrued interest paid with the purchase of a bond is included in the ACB; of course, this means that this results in a lower capital gain and increases interest income.

Having done it several times for myself and a friend, never a comeback from CRA

I disagree 100%

Acrued interest paid is «Financial Expences and Interest Cost», to be entered on schedule 4 part IV

The transaction statment of the broker makes this very clear also....it is brokent into two parts

Cost of the bond + accrued interest

At year end, with the T5 you get a breakdown

1) Interest PAID BY YOU

2) Interest PAID TO YOU....only the last portion is shownt on the T 5 box 13

3) If held to maturity...the difference betweene the COST OF THE BOND and the FACE VALUE becomes a capital gain or loss

In some cases the accrued interest was quiet big, as we were making an INCOME PORTFOLIO to pay the groceries, so we wanted the interest payements spread over differend monts

Even audited, no questions were asked about the treatment of the accrued interest

The opinions we are getting from «CRA info» are very often NOT RELIABLE and can be easely challenged

my opinion

[billiam]

Perhaps a quick google on "accrued bond interest" would have found you this amoung others:

https://www.investorsedge.cibc.com/i...-taxation.html

or

http://www.taxtips.ca/personaltax/in...ment/bonds.htm