Tuesday, January 24, 2017

Buying Bonds

Bonds are easy to buy and if you have good quality bonds like government bonds or good corporate bonds, then risk is slight and you will get back your capital if you hold the bond to maturity. People do not realize that the bond market is a lot riskier than the stock market. Bonds are only a safe investment if you buy and hold them until maturity.

What you do is phone your broker and ask for what they have in bonds. You are quoted a price per $100 of bond values. If you are buying a new issue, the asking price will be $100. However, if you buy a bond that is already issued, you will price a price per $100 of bond. If the bond has an interest rate above the current interest rate, then you will be quoted a price above $100 of the bond's amount. If the bond has an interest rate above the below interest rate, then you will be quoted a price below $100 of the bond's amount.

At maturity a bond will pay $100 per $100 of face amount. So if you paid a price below $100 of face amount, then you will end up with a capital gain between what you paid and the $100 of face amount. If you paid a price above $100 of face amount, then you will end up with a capital loss between what you paid the $100 of face amount.

When you buy a bond, the interest rate you will get is the current one for the type and duration of that bond. If you are getting a higher interest rate that the bond has then you will be quoted a price lower than $100. If you are getting lower interest rate than the bond has then you will be quoted a price higher than $100.

Say you were quoted $106.38 and were buying a bond with a face of $1000. You would be paying $1063.80 for the bond. What you will get by the maturity of the bond is the interest rate promised and the return of the money you paid. The interest payments you receive will be more than those quoted, but you will have a capital loss.

In this example the capital loss would be $63.80. The net amount you will receive is $24.81. You will pay tax on the $88.61 you actually receive in Interest and have a capital loss of $63.80 to be used against any capital gains you have. When you buy the bond you will also paid interest due between the last interest payment and the date you buy the bond. In this example, that would be $5.14.

Issuer Amount Coupon Maturity Paid Int Rate Paid
Gov of CDN $1,000.00 3.75% 1-Jun-19 $106.38 0.99647% $1,063.80
Int pd yrly $37.50 -$63.80 Cap Loss
Mths paid Jun/Dec Jun/Dec
Net Rec Int Inc
1-Dec-16
20-Jan-17 -$1,063.80
50 Days -$5.14 -$5.14
1-Jun-17 $18.75 $18.75
1-Dec-17 $18.75 $18.75
1-Jun-18 $18.75 $18.75
1-Dec-18 $18.75 $18.75
1-Jun-19 $18.75 $18.75
$1,000.00
Sum $24.81 $88.61 Int. Inc.

In another example, say you were quoted $99.796 and were buying a bond with a face of $1000. You would be paying $$997.96 for the bond. What you will get by the maturity of the bond is the interest rate promised and the return of the money you paid. The interest payments you receive will be less than those quoted, but this will be made up for the fact that you will receive back $1000 or $2.04 more than the $997.96 you paid for the bond.

In this example the capital gain would be $2.04. The net amount you will receive is $14.79. You will pay tax on the $12.75 you actually receive in Interest and the capital gain of $2.40. When you buy the bond you will also paid interest due between the last interest payment and the date you buy the bond. In this example, that would be $0.55.

Issuer Amount Coupon Maturity Paid Int Rate Paid
BNS $1,000.00 1.33% 5-Jan-18 $99.796 1.49323% $997.96
Int pd yrly $13.30 $2.04 Cap Gain
Mths paid Jan/Jul
Net Rec Int Inc
5-Jan-17
20-Jan-17 -$997.96
15 -$0.55 -$0.55
5-Jul-17 $6.65 $6.65
5-Jan-18 $6.65 $6.65
5-Jan-18 $1,000.00
$14.79 $12.75 Int. Inc.

The thing is that it is not risky in buying a bond on the open market and holding it until maturity. The risk is that if interest rates go up, the value of your bond will go down and people can panic and sell a bond on the open market. The bond market is risky when you buy and sell on the open market. However, if you hold that bond until maturity and ignore the current market price, you will get your money back.

On my other blog I wrote yesterday about National Bank of Canada (TSX-NA, OTC-NTIOF)... learn more. Tomorrow, I will write Transcontinental Inc. (TSX-TCL, OTC-TCLAF)... learn more on Wednesday, January 25, 2017 around 5 pm.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. I do research for my own edification and I am willing to share. I write what I think and I may or may not be correct.

See my site for an index to these blog entries and for stocks followed. I have three blogs. The first talks only about specific stocks and is called Investment Talk. The second one contains information on mostly investing and is called Investing Economics Mostly. My last blog is for my book reviews and it is called Non-Fiction Mostly. Follow me on Twitter.

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