How bonds work
There are different types of bonds, but experts note they all work in a similar fashion — the business, federal government agency or local government that needs money issues a batch of bonds.
Unlike with stocks, bondholders don’t buy into a piece of the company. Instead, they loan the business or government a sum of money for a predetermined period of time. The issuer sets a term and interest rate for the loan. Once the term or maturity date is reached, the lenders get their investment back along with the interest earned.
The amount of extra money bondholders receive depends on the interest rate, also called the coupon rate. The longer a bond’s term, the higher the coupon rate will typically be. For example, rates for government of Canada bonds are running about 0.5 per cent to 2 per cent, with the higher end for bonds you hold 10 years or more.
Buying bonds is pretty straightforward. You can purchase a specific bond or a bond fund, composed of multiple, and sometimes dozens of bonds. You buy them through a brokerage account, on an investing platform, or directly from the issuing government agency or corporation.
The different types of bonds
Though less volatile than many investments, bonds have differing levels of risk that correspond with their yields. What’s at risk is potentially losing your initial investment if the bond issuer defaults on its loan.
Lowest-risk bonds come from sources that are most likely to pay back their loans. Typically, these are government-backed bonds. But when there’s less risk, expect a lower yield.
Low-risk government bonds:
- Municipal — Bonds issued by cities, school districts or other bodies in provincial government regions are fairly uncommon in Canada, but these “muni” bonds tend to provide high yields. The money often goes to repair roads, build schools or fund other infrastructure.
- Canadian Treasury — The federal government has similar reasons for issuing treasury bonds. The projects are, of course, much larger.
- Agency — Agency bonds fund specific government arms, such as Health Canada or the Canada Revenue Agency.
Corporate bonds with varied levels of risk:
- Corporate — Companies rely on these loans to fund large growth initiatives like new equipment or property purchases, research and development, or workforce increases.
- Convertible — Convertible bonds, experts note, are a type of corporate bond that holders can exchange for shares of the issuing company.
- Junk — Junk, or high-yield bonds, are another type of corporate bond. They’re riskier than more traditional bonds but can reap solid returns. That’s because these bonds are issued by corporations that have lower credit ratings from investment services — and if taking that risk pays off, it would translate into an investor’s reward.
The bonds listed above are for Canadian governments and companies. If you want to invest in international bonds, you can buy foreign bonds (in Canadian dollars) on the Canadian market.
All of these bond types give individual investors an opportunity to provide one piece of a group-funded loan, functioning like a large lender would, to provide an organization with the money it needs.