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Characteristics of bonds

Some basic information about bonds.

Face value

Corporate bonds normally have a par value of $1,000, but this amount can be much greater for government bonds.

Interest

Most bonds pay interest every 6 months, but it's possible for them to pay monthly, quarterly or annually.

Coupon or interest rate

Fixed-rate bonds generate a constant interest rate. You receive the same amount each year or month, depending on the interest payment schedule.

There are also 2 types of floating-rate bonds. The interest rate is either set in advance each year or tied to market rates.

Step-up bonds have yields that increase over a set period (e.g., 4% the first year, 4.5% the second year, etc,). They can also be bought back at the issuer's choosing.

Other bonds have an adjustable floating rate, tied to market rates such as Treasury bills. If Treasury bill yields to up, the investor wins out. The reverse also is true: if yields go down, the bond issuer wins out.

Fixed-rate bonds are therefore considered safer than floating-rate bonds, but their yield may be lower.

Maturity

Maturities can range from as little as one day to as long as 30 years (though terms of 100 years have been issued!

A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years. Therefore, the longer the time to maturity, the higher the interest rate. Also, a longer term bond will fluctuate more than a shorter term bond.

Issuers

The issuer's stability is your main assurance of getting paid back when the bond matures.

For example, the Canadian and U.S. governments are far more secure than any corporation. Their default risk–the chance of the debt not being paid back–is extremely small, so small that they are considered risk free assets. The reason behind this is that a government will always be able to bring in future revenue through taxation.

A company on the other hand must continue to make profits, which is far from guaranteed. This means the corporations must offer a higher yield in order to entice investors–this is the risk/return trade-off in action.

Rating agencies

The bond rating system helps investors distinguish a company's or government's credit risk.

Blue-chip firms, which are safer investments, have a high rating while risky companies have a low rating.

The chart below illustrates the different bond rating scales from the major rating agencies: Moody's, Standard & Poor's ("S&P") and Dominion Bond Rating Service ("DBRS").

Moody's S&P DBRS Risk
Aaa AAA AAA Highest quality
Aa AA AA Highquality
A A A Strong
Baa BBB BBB Medium grade
Ba, B BB, B BB, B Speculative ("Junk")
Caa, Ca, C CCC, CC, C CCC, CC, C Highly speculative
C D D In default

The "junk bond" category is aptly named because they're the debt of companies in some sort of financial difficulty.

Because they're so risky, junk bonds have to offer much higher yields than any other debt. This brings up an important point: Not all bonds are inherently safer than stocks. Certain types of bonds can be just as risky, if not more risky, than stocks.

Tools and tips

How bonds work

When you buy a bond, you are lending money to a government or a company.

Read tip - How bonds work

Understanding bond yields

When a bond's price goes up, its yield goes down. The explanation.

Read tip - Understanding bond yields

Types of bonds

Discover the 3 main categories of bonds.

Read tip - Types of bonds

How to read a bond table

What the columns in a bond table stand for.

Read tip - How to read a bond table

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