Escolar Documentos
Profissional Documentos
Cultura Documentos
What is a bond?
You've just loaned your neighbour $1,000 so that he can renovate his home. He's promised to pay you 6% interest each year for the next 5 years, and then hell give you back your money. A bond works much the same way you give a company $1,000 and they pay you a fixed rate of interest for a specified period of time, after which they return your principal. Governments (federal, provincial and municipal) and corporations use bonds to raise the capital they need to expand.
Total principal and Year 5 (6% interest (at maturity interest on $1,000) date of 5 years) $1,300.00
You could also decide to sell that bond to someone else for $1,100. In that case youd earn a capital gain of $100 (plus whatever interest payments you had received in the meantime). Now, why would someone pay you $1,100 for a bond that only cost you $1,000?
Selling bonds
Your $1,000 bond pays 6% interest. Since you bought that bond, however, interest rates have gone down. Similar companies are now only offering a 5% interest rate on their bonds. Your original rate looks pretty good to another investor. So you can sell that 6% bond at a higher cost than you paid for it, which is called selling for a premium.
However, if interest rates have gone up, and similar companies are now offering 8%, you may have to sell your bond for less which is known as selling at a discount. Interest rates and bond prices, then, are like a see-saw when interest rates go down, bond prices go up (and vice versa).
Risk factors
As we've seen in the previous slide, if you decide to sell your bond before the time is up, youll face interest rate risk. In other words, if rates have gone up, you may have to sell your bond at a discount. If you decide to just sit tight and keep your bond until maturity, you dont need to worry about interest rate risk. Youll keep earning your 6%. You still need to be concerned about the company's ability (assuming you purchased a corporate bond) to keep paying interest.
If business isn't going well, the company might miss a payment. If things are really going badly, they might go bankrupt meaning you stand to lose not only your 6% interest payment, but some or even all of your original investment. Clearly a new, smaller company is going to have to offer a higher rate of return to attract investors. After all, why would you accept the higher risk if you could get the same rate from the federal or provincial government bond?
Mutual funds
A mutual fund is really just a basketful of investments. Investors dont buy the actual investments, but rather buy shares, or units, of the entire basket. Lets say that the fund holds investments worth $100,000. If there is a total of 100,000 units in the fund, each unit would be worth $1. If the value of the investments inside the fund were to go up to $200,000, each unit will now be worth $2. If you held 5 units, you would have earned $5.
Long-term bonds are great for someone looking for a reliable stream of income, but they're also more sensitive to changes in interest rates. If prevailing interest rates go up, the price of longer term bonds will go down further than short- or medium-term bonds. While there are general bond funds, which will hold a selection of short-, medium- and longterm bonds, there are also funds that specialize in one type of bond. For example, it's possible to buy units of a fund that only invests in long-term bonds; the potential for returns is higher, but so is the risk.
From here
If youre interested in what bonds might be able to do for you, we should discuss and assess your investment comfort level and define what your personal goals are. Once weve determined the level of risk youre prepared to accept, I'll be able to either recommend an appropriate portfolio myself, or I'll refer you to a bond specialist.