# Bond Basics



## Robillard (Apr 11, 2009)

In the thread on the explanation of the national debt, forum member byron84 asked some fundamental questions about bonds. In this post, I will try to clarify some of the basic terminology and mechanics of how bonds work. If I make any mistakes, please correct me.

A bond is basically a big loan broken up into tiny identical pieces. When a corporation or government wants to raise a lot of money in the capital markets, they can issue bonds and sell them to investors. A bond is a legal obligation in which the borrower agrees to pay *coupons* to the investors at fixed intervals until the bond *matures*. On the date that the bond matures, the borrower will redeem the bond and pay the investor the *face value* of the bond. The redemption of the bond ends the legal obligation of the borrower to the investor. Unless the bond has an embedded call option, bonds cannot be redeemed by the issuer prior to the maturity date. 

Bonds can be very complicated instruments, since issuers and their advisors (investment banks) can tailor the suit their needs and those of the market. In the most basic type of bond, there are key characteristics as follows:

*Maturity date* - As was described above, this is the date that the bond issuer agrees to redeem the bonds and pay the face value to the bondholder. Typically it is also the date of the last coupon payment.

Face value - These days bonds are no longer issued as physical paper certificates, but in the olden days, every bond certificate had amount printed on it that indicated the amount of money the bond issuer agreed to pay the investor on the maturity date. It is common practice in North America these days for the face value of a bond to be in $1000 increments.

Coupon - In olden days, bonds had perforated sections referred to as coupons that could be torn off and redeemed for the agreed amount of coupon payment; these days this is all done electronically.

*Coupon rate* - The coupon rate is the ratio of coupon payment to the face value of the bond a 5% coupon bond with a face value of $1000 will make annual coupon payments of $50 during the year. 

*Coupon frequency* - This is the number of times that coupon payments are made during the year. By tradition, in North America most bonds make two coupon payments per year. A $1000 face value bond with a 5% coupon rate making two payments per year will pay $25 twice a year at 6 month intervals. Not all bonds have the same coupon frequency though!

*Yield-to-maturity* and *purchase price* - I have put these two together because they are intimately related. The yield-to-maturity is the discount rate that is applied to all the future cash flows of the bond to determine the price. The yield-to-maturity represents the return the investor will earn assuming that the bond is held to maturity, that all coupon payments are reinvested at an equivalent interest rate, and that the bond issuer does not default. The price at purchase is the present value of all the remaining coupon payments and the face value discounted at the yield-to-maturity. The mathematics of discounting cash flows are best described elsewhere for now.

*Yield* and *price* - More generically, you might hear people talk about bond yields. The yield on the open market represents the lowest return that investors are willing to accept from purchasing that bond issue. The price of a bond on the open market is is equal to the present value of the future payments of the bond (coupons and face value) discounted at the prevailing yield for that bond issue. When the yield is equal to the coupon rate, then the bond price is simply equal to its face value (referred to as *trading at par value*). When the yield is above the coupon rate, the bond is *trading at a discount*, meaning that the current price is less than face value. When the yield is below the coupon rate, the bond is *trading at a premium*, meaning that the current price is above face value. Bond yields are influenced by a number of factors including prevailing interest rates, the creditworthiness of the bond issuer (i.e. expectation of default), and relative demand for bonds compared to other investments.

If you go to your investment advisor and inquire about purchasing a bond, they will probably call their institution's bond trading desk and ask at what price and yield the bond issue is being offered. Incidentally, bonds are traded in the *over-the-counter market*, between bond dealers, banks and other market participants - as opposed to stocks which are traded on relatively centralised exchanges. If you agree to purchase the bond at the quoted price and yield, then the bond trading desk will purchase the bond on the open market and place it in your brokerage account. The minimum amount of a bond purchase in Canada is typically $5000 of face value (if the bond is trading at a discount, then the purchase price will obviously be less than $5000) and in $1000 increments. Bond prices are usually quoted as an amount per $100 of face value. So a bond offered at 102 is trading at a premium, and the minimum purchase would be $5100. 

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.


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## OntFA (May 19, 2009)

A few practical tips on bonds:

Don't buy a bond directly unless you plan to hold it until maturity. Otherwise, you could get taken to the cleaners on embedded trading costs.

Also, most individual investors are best to buy strip bonds so that you don't have small interest or coupon payments to reinvest - which is hard to do in a cost effective way.

On that note, the yield to maturity is a bit mythical since you can only realize that by reinvesting all of your coupons at the YTM with no cost so it's an indication of the yield available to you but the only way for you to get the full YTM or higher is if yields rise as you 'clip your coupons'.

Stick to high quality (government of Canada or a province).

If you want to go into something like corporate bonds stick to a fund or ETF and limit that to no more than 1/3 or so of your total allocation to bonds.


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## tojo (Apr 20, 2009)

OntFA said:


> A few practical tips on bonds:
> 
> Stick to high quality (government of Canada or a province).
> 
> If you want to go into something like corporate bonds stick to a fund or ETF and limit that to no more than 1/3 or so of your total allocation to bonds.


Would any of you gentlemen know the best way to purchase decent quality corporate bonds. I don't have the resources, going through my discount broker...the buy/sell spreads are a rip-off, and it appears the juicy yields from a few months ago are no more. For example, I do see "LOBLAWS MTN CANADA CALLABLE" coupon 6.45%, listed at a discount sell yield 7.88%, buy yield 7.49% maturing 03/01/2039 (that's a long time from now!). Would you trust a name like this, rated BBBm (DBRS)? I've resorted to PH&N High Yield Bond Fund and Bond Index funds, - but I hate paying the MER. Thanks.


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## OntFA (May 19, 2009)

tojo said:


> Would any of you gentlemen know the best way to purchase decent quality corporate bonds. I don't have the resources, going through my discount broker...the buy/sell spreads are a rip-off, and it appears the juicy yields from a few months ago are no more. For example, I do see "LOBLAWS MTN CANADA CALLABLE" coupon 6.45%, listed at a discount sell yield 7.88%, buy yield 7.49% maturing 03/01/2039 (that's a long time from now!). Would you trust a name like this, rated BBBm (DBRS)? I've resorted to PH&N High Yield Bond Fund and Bond Index funds, - but I hate paying the MER. Thanks.


You will pay one way or another. Take a look at ETFs by iShares and Claymore for the cheapest corporate bond exposure. Otherwise, the PH&N fund is a great one too. I would not advise anyone, even with six figures, buy corporate bonds directly. As you admit yourself, the spreads are a great deal for the bond desk but not for you. Remember too, with funds, you'll have an easier time reinvesting the relatively larger interest payments offered today.


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## tojo (Apr 20, 2009)

OntFA said:


> You will pay one way or another. Take a look at ETFs by iShares and Claymore for the cheapest corporate bond exposure. Otherwise, the PH&N fund is a great one too. I would not advise anyone, even with six figures, buy corporate bonds directly. As you admit yourself, the spreads are a great deal for the bond desk but not for you. Remember too, with funds, you'll have an easier time reinvesting the relatively larger interest payments offered today.


the bond market is not designed for the retail investor like us....very unfair...I'll take your advice - have enough on my hands with maintaining my pref portfolio - and stick with low cost bond funds. Thanks!


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## Robillard (Apr 11, 2009)

tojo,
The issue you mentioned does mature in 2039, but since that issue is callable, there is a reasonable probability that the issuer will call the bond prior to maturity. If you want to find more information about a specific issue, you can try looking for the prospectus on SEDAR, which is a repository of public company documents. Incidentally you can also find information on investment fund companies here.

As for the spread, yes, the spreads are wide. I wouldn't be surprised if bonds spreads were wider in Canada than the US. Certainly bond spreads are wider than stock price spreads, especially on long-term bonds, but when you consider the costs of executing stock trades in comparison to the spreads on bond yields, they are fairly comparable if you are comparing against short term bonds. Consider Royal Bank of Canada's issue 4.97% coupon issue that matures on June 5, 2014. My discount broker is quoting a bid at 105.419 and an offer at 106.851 (the associated yields are bid at 3.77454%, offered at 3.47076%). A $5000 face value purchase would cost $5342.55 (ignoring accrued coupon interest). A seller would receive $5270.95 (ignoring accrued coupon interest). That puts the spread at $71.60. If you compare that against the cost of executing a buy and sell on a stock at anywhere from $10 to $40 per trade, plus a per share amount, in addition to the built in spread in the market (spreads on low-volume TSX issues can be a lot wider than 1 cent per share). So you see, the bond spreads are not necessarily much worse than an expensive discount broker's execution costs for stocks. Long term bonds have wider spreads than short term bonds though.


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## leslie (May 25, 2009)

I agree that bond market is not set up for retail investors, except to rip us off. I buy exchange traded debt instead - prefs and debentures. They also have their problems, but they beat being held at gunpoint by our brokers.


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## tojo (Apr 20, 2009)

Robillard said:


> tojo,
> Consider Royal Bank of Canada's issue 4.97% coupon issue that matures on June 5, 2014. My discount broker is quoting a bid at 105.419 and an offer at 106.851 (the associated yields are bid at 3.77454%, offered at 3.47076%). A $5000 face value purchase would cost $5342.55 (ignoring accrued coupon interest). A seller would receive $5270.95 (ignoring accrued coupon interest). That puts the spread at $71.60.


Robillard,

Brookfield came out with a new issue today. I've pasted some details below. I admit I don't know much about this type of fixed income, but what would you consider as the risks in holding such a product. I hold a few pref issues from them, but nothing like the below....the terms seem much more attractive than on the fixed income board. Thanks in advance... 

Note: I see the minimum quantity is a bit high! Which will prevent me from buying it as a new issue - it closed fast anyways.


Brookfield Asset Management 8.95% Senior Unsecured Notes 02Jun14 
Short Description: Offering of Unsecured Notes 
Size of Issue: $500-million 
Category: Fixed Income 
Price: $99.802 CDN per $100 par value
Coupon: 8.95 % per annum paid semi-annually 
Coupon Frequency: Semi-annually 
Yield To Maturity: 9.00% semi-annual; 9.20% annual 
Spread 649.6 basis points above the yield of the Government of Canada 3.00% June 2014 
Maturity: Jun 02, 2014 
Settlement Date: June 2, 2009 
RSP Eligible: Yes 
RSP Content Domestic 
Lot Size: 1,000 
Min. Quantity: 5,000 
Max. Quantity: 50,000 
Ratings: DBRS: A S&P: A- Moody's: Baa2


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## Robillard (Apr 11, 2009)

Tojo,
The key risks for in most bond issues are the same. They consist of interest rate risk, reinvestment risk, inflation risk, default risk and credit rating risk (this could also be called downgrade risk). There are risks relating to the shape of the yield curve, but that might be too complex to discuss at this point.

All bonds with fixed coupons are exposed to interest rate risk. Basically, when interest rates for bonds with a similar maturity increase, bond yields rise, and thus the price falls. If the Bank of Canada raises the target overnight lending rate by 25 basis point, this does not exactly translate into the same increase in the yields on all bonds. Some, particularly long term issues, might be totally unaffected, but short term issues are definitely affected. In general though, increases in interest rates are almost universally decrease the value of bonds.

Reinvestment risk has to do with the problem of reinvesting coupon payments. When you buy bonds, you purchase them at a set yield-to-maturity, which is the expected return you would earn if you were able to reinvest each coupon payment at the same yield rate. Unfortunately, there is no such thing as DRIPs on bonds. As such, there is no way to guarantee you will actually realise the yield-to-maturity since you don't know at what interest rate you will be able to reinvest the coupon payments.

Inflation risk has to do with the risk that inflation rises and decreases the purchasing power of your investment. When inflation increases, bond yields tend to increase (driving down bond prices) because new investors demand compensation the the expected decrease in the real return that the bond will yield. If inflation is increasing prices at 2% per year, then a 6% nominal yield on a bond is really only yielding a real return of about 4%. While stocks prices have a tendency to keep pace with inflation because corporations tend to increase dividends to keep pace, bond returns get clobbered by inflation since in most cases the coupon payments and the repayment at maturity are fixed. 

Default risk is simply the risk that the issuer is unable to pay the coupon interest payments or repay the face value at maturity and goes bankrupt. In bankruptcy though, bondholders tend to fare better than shareholders because bondholders have a higher priority claim on a company's assets than the shareholders. Senior issues backed by specific collateral have the lowest default risk, while subordinated unsecured issues have the highest risk (which is still lower than the risk to the common shareholders). Long term bonds have more default risk than short term bonds.

Related to default risk is credit rating risk. Credit rating agencies usually provide an issue-specific rating on a bond when it is issued, and then continue watching the company to ensure that its ability to make coupon payments and repay at maturity isn't changing. If a credit rating agency things a company's ability to service its debts is deteriorating, it will put it on watch for a credit rating downgrade. If the credit rating does get downgraded, then the bond yields demanded in the market for that issue will rise. Of course, a downgrade doesn't affect the investor's ability to realise the yield-to-maturity so long as the issuer can continue to make coupon payments and repay at maturity. It does affect the investor's ability to sell the bond and break even though. Take the Brookfield issue as an example. Suppose you bought part of this issue and soon afterwards S&P cut the credit rating on the issue from A- to BBB. This would cause the yield demanded in the market to increase above the 9.00% at which you bought the issue. As long as Brookfield can continue to service its debts, your ability to realise that 9% return is not in much jeopardy (keeping in mind what I already said about reinvestment risk), but if you try to sell your bonds, you will probably get less than what you paid for them.

As for what you said about the terms of the new issue being more attractive than those currently on the market. This is an illusion. The fact is, that a spread is already built in to the price. The institutions in the bond underwriting syndicate might have only paid Brookfield $99.00 for $100 of face value, and then sold most of the issue to the selling group members of the syndicate at $99.50 for $100 of face value. The selling group members then go and sell to investors at say, $99.75 for $100 of face value. There is no getting around this; an investors can't buy the issue at $99.00, which was the price that the syndicate members paid. Individual investors probably get the worst deal, as large volume purchasers, such as mutual funds, may be able to negotiate a better price than $99.75 with the selling group. 

Really, I wouldn't read too much into the width of the bid/offer spread on the market. If I was going to hold a bond to maturity, I wouldn't be too concerned with the bids of bond dealers. Bonds are not meant for frequent trading (arguably, neither are most stocks). If you buy and sell bonds a lot, the bid/offer spread can be a profit killer; so don't do it. At the same time though, bonds aren't just about interest income. If you expect interest rates or credit spreads (roughly the spread between the bond's yield and the yield of a risk-free government bond with close to the same maturity date) to fall, then you might be able to sell prior to maturity and net a healthy capital gain.


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## tojo (Apr 20, 2009)

Robillard said:


> Tojo,
> The key risks for in most bond issues are the same. They consist of interest rate risk, reinvestment risk, inflation risk, default risk and credit rating risk (this could also be called downgrade risk). There are risks relating to the shape of the yield curve, but that might be too complex to discuss at this point.


Robillard, your detailed response is informative and very much appreciated. I have a better understanding of bonds now .


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## gregorj (Jun 17, 2009)

*Canada Premium Bond Series 4*

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?


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## Robillard (Apr 11, 2009)

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.


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## gregorj (Jun 17, 2009)

*Re: Canada Premium Bonds Series 4*

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.


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## heyjude (May 16, 2009)

Great thread, thank you Robillard!

Can you explain Real Return Bonds?


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## leslie (May 25, 2009)

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


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## Robillard (Apr 11, 2009)

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


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## leslie (May 25, 2009)

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


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## johnsazzr (Apr 20, 2009)

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)


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## zylon (Oct 27, 2010)

*Bump*

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.


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## KaeJS (Sep 28, 2010)

zylon said:


> 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.


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## Jungle (Feb 17, 2010)

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.


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## KaeJS (Sep 28, 2010)

Jungle said:


> 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.


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## zylon (Oct 27, 2010)

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*. 



KaeJS said:


> ... 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)
        [B]$898.00[/B] total income - taxed annually as interest

On the maturity date I receive back $5,000
- with a result of [B]$127.90[/B] 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.


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## KaeJS (Sep 28, 2010)

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.


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## KaeJS (Sep 28, 2010)

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

Which, if I did everything properly...

Is a steady *3.05*206731% per annum, not compounded.


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## zylon (Oct 27, 2010)

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.


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## investorgirl (Nov 12, 2011)

*Accrued Interest Paid vs. Interest Earned ― Tax Treatment?*



Robillard said:


> ...
> 
> 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 VALUEPRICE at BUYPRICE PAIDINTEREST ACCRUED (PAID)5000102$5000 × 102% = $5100$5000 × 5% × days (where days is 10/365) = $6.85FACE VALUEPRICE AT SELLPRICE RECEIVEDACCRUED INTEREST (RECD)5000104$5000 × 104% = $5200$5000 × 5% × days (where days is 45/365) = $30.82+ Coupon Payment = $125Total 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


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## investorgirl (Nov 12, 2011)

*Accrued Interest Paid vs. Interest Earned ― Tax Treatment ➙ Included in ACB*



investorgirl said:


> ...
> 
> 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:
> 
> ...


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)


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## caricole (Mar 12, 2012)

investorgirl said:


> 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%:hopelessness:

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


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## billiam (Aug 24, 2009)

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

https://www.investorsedge.cibc.com/ie/education-centre/topics/fixed-income/bonds-taxation.html

or

http://www.taxtips.ca/personaltax/investing/taxtreatment/bonds.htm


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