With corporate bonds, the coupon or interest is usually taxable. Therefore the bondholder would be wise to investigate whether a particular bond coupon should be listed as income on the tax return. Since corporations are much smaller than countries, the risk of collapse before your bond matures is far greater; although it could be argued that companies like Microsoft bear a greater deal of stability then most countries.

Some corporate bonds have a call option, which allows the investor to redeem their principal before the bond matures. However there may be fees and penalties involved when the investor attempts to do this. Needless to say it would be prudent to understand the conditions of your call option before you redeem.

Some corporate bonds are known as convertible. This means you have the option to convert your corporate bonds to equity shares within that company. This way you can keep abreast of market performance by shifting your portfolio to best suit the market environment and your willingness for risk.

Before investing in corporate bonds, you may want to check the option adjusted spread. This compares the corporate bond against the government bond market to measure the discrepancy of risk between the two. Checking the option spread will allow you to make an informed decision on the risk involved.

The world of bonds stretches much further than this, so look forward to more articles on the subject.
Bond and debentures
The bond market
Bond classes

Government bonds, unlike corporate bonds, are sold based on currency. This means that when you invest in a Canada Savings Bond, you are investing in the Canadian Dollar. If you were to invest in a Corporate Bond, you would be investing in the company itself.

(Note: that the Canada Savings Bonds are not actually bonds but debentures. Remember that a bond holds some type of asset as security against the loan. However, the Canadian government will probably not default as they can always print more money – so I suppose that it is a bond with the valuation of our currency as collateral. Besides Canada Savings Debentures just doesn’t quite roll off the tongue in the same way.)

Government bonds have classically experienced less risk because currency markets tend to be more stable, especially ones in western countries. However, they do bear currency risk as witnessed with the 1998 ruble crisis in Russia where the value of their currency plummeted taking their bond values with it. If you want to avoid a majority of currency risk when your domestic currency is in fluctuation, you may want to purchase what is referred to as a sovereign bond. This means that you are still buying from your government, but you are invested in a foreign currency. You may also face inflation risk when purchasing government bonds. This means that the principal you are paid at maturity is worth less then what it was when you bought the bond in the first place. If you are afraid of this occurrence, you may want to look into the availability of inflation-indexed bonds.

Before any bond investment, it would be wise to research the parameters and the potential return on ones of interest to you. Next we will discuss corporate bonds and how they affect the potential investor.

Missed the previous posts in this series?
Bond and debentures
The bond market

Fixed income bonds are traded securities that are guaranteed to pay off a regular interest or coupon to the investor. These bonds behave somewhat as preferred shares issued by corporate entities (except that a bond is a debt, whereas a share is equity). When you are looking to purchase fixed income bonds you should be aware of the following terminology.

Like a loan, the “principal” of the bond is the amount that the holder has lent the institution for capital. The interest that the borrower agrees to pay the bondholder is referred to as the “coupon.” Bonds are sold with a certain life expectancy. When that stated time period is up, it is said that the bond has matured and the money lent is to be returned to the bondholder. When the bondholder enters into an agreement to purchase bonds, it is said that they receive issue (bond) from an issuer (entity that is borrowing the money) and the two parties formalize an indenture (the contract).

In the next segment, we will discuss the differences between government and corporate bonds.

Missed the first posts in the series?
Bond and debentures

First of, what is a bond? A bond is a debt instrument that is secured by some asset(s). A common example of a bond is a mortgage. When you get a mortgage from your bank you are getting a loan that is secured by the house. If you stop making your promised payments then the bank can take the asset (your house). There are many types of bonds, issued by a variety of parties from all levels of government and corporations, long and short term durations, with a variety of features.

Most people have heard of bonds, but not many have heard of debentures. A debenture is similar to a bond in that it is a debt instrument, however it lacks an asset to secure the debt. In other words a debenture is a lot like a loan to your cousin Jimmy simple because you think ‘he’s good for it.’

Well, how do we know some organization is good for it? Unfortunately, we don’t.  However a few companies give credit ratings the the borrowing organizations.  Generally, the worse the credit rating the higher, the higher the risk of default, the cost of borrowing.

Next time we’ll look at coupons… oh boy, I love coupons.