Chapter 12:

Investing in
Bonds

Ted Stephenson, MBA, CFA, CFP

George Brown College

 2021 McGraw-Hill Education Limited

 Chapter 12: Learning Outcomes
(LOs)
LO1 Describe the characteristics of corporate
bonds.
LO2 Discuss why corporations issue bonds.
LO3 Explain why investors purchase corporate
bonds.
LO4 Discuss why federal, provincial, and
municipal governments issue bonds and why
investors purchase government bonds.
LO5 Evaluate bonds when making an investment.2
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Characteristics of Corporate Bonds (1)
Describe the Characteristics of Corporate Bonds
Corporation’s written pledge to repay a specified

amount of money along with interest

The face value is the dollar amount that the bondholder

will receive at the bond’s maturity date

Maturity date is the date on which the corporation is

to repay the borrowed money

The legal conditions are described in a bond indenture

Bond indenture is a legal document that details all the

conditions relating to a bond issue

A trustee is the bondholder’s representative
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Characteristics of Corporate Bonds (2)

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Characteristics of Corporate Bonds (3)

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Characteristics of Corporate Bonds (4)
 Between time of issue and maturity, corporations pay
interest to bondholders, usually semi-annually, at
stated rate (coupon rate)

Dollar Amount of = Face Value × Interest

Annual Interest (Coupon) Rate

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Why Corporations Sell Corporate Bonds (1)
Discuss Why Corporations Issue Bonds

Why Corporations Issue Bonds

To borrow money to pay for major purchases

Difficult or impossible to sell stock

Finance ongoing business activities

To get money to operate or expand

The interest paid to bondholders is a tax

deductible business expense

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Why Corporations Sell Corporate Bonds (2)
Types of Bonds

1.Debenture Bond
 Most corporate bonds are debenture bonds
 Backed only by the reputation of the issuing company
2.Mortgage Bond
 A corporate bond that is secured by various assets of
the issuing firm

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Why Corporations Sell Corporate Bonds (3)

Types of Bonds

3.Subordinated Debenture Bond

 An unsecured bond that gives bondholders a claim
secondary to that of other designated bond holders with
respect to interest payments and assets
4.Convertible Bonds and Bonds with Warrants
 Can be exchanged, at the owner’s option, for a specified
number of shares of common stock
 A warrant is an option that gives the holder the right to
purchase the firm’s common shares at a set price for a
predetermined period, usually a number of years. 9
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Why Corporations Sell Corporate Bonds (4)
Provisions for Repayment
Call feature:
 Corporation can call in or buy back outstanding bonds

from current bondholders before the maturity date.

 Most agree not to call bonds for the first 5 to 10 years

after they are issued.

 They call bonds if the interest rate they are paying you

is very much higher than the going rate.

 Most corporate bonds and municipal bonds are callable.

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Why Corporations Sell Corporate Bonds (5)
Provisions for Repayment

Sinking fund:
 A fund to which annual or semi-annual deposits are
made for the purpose of redeeming a bond issue
Serial bonds:
 One issue of bonds that mature at different dates

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Why Corporations Sell Corporate Bonds (6)
Other Types of Bonds

Domestic, Foreign, and Eurobonds

 Issued in the country and currency of the issuer
Units
 Two or more corporate securities bundled by an
investment dealer and sold at an overall price
Strip Bonds
 Coupons and bonds are sold separately at significant
discounts
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Why Investors Purchase Corporate Bonds
(1)
Explain Why Investors Purchase Corporate Bonds
Stocks Always Beat Bonds: Myth of Fact?
Even if stocks do not always beat bonds, the financial industry will
tell you otherwise because most brokerage firm profits come from
investment banking commissions on stocks.
 Stock commissions 2.5%.
 Bond commissions 1.5%.
 Money market commissions 0.5%.
However, there have been many long periods when bonds or T-bills
have outperformed stocks. Using the Canadian Long-Term Bond total
return index and the S&P TSX Composite index, the period from 1970
to 2016 shows the bond index performing as well as or better than the
stock index.
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Why Investors Purchase Corporate Bonds
(2)
 For interest income
 Investors know the interest rate
 Interest will be paid to investors twice a year
 Appreciation of bond value
 May be able to sell the bond to someone else at a
higher price if the interest rate on the bond is higher
than the market rate
 Bond face amount will be repaid at maturity

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Why Investors Purchase Corporate Bonds
(3)
Interest Income
Method used to pay bondholders their interest depends
on how the bond is registered.
 A registered bond is registered in your name by the
company or government who issued it.
 A registered coupon bond is registered for principal
only and not for interest.
 A bearer bond is not registered in the investor’s name.
 A zero coupon bond is sold well below face value, pays
no interest, but is redeemed for face value at maturity.
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Why Investors Purchase Corporate Bonds
(4)
Changes In Bond Value
Price of corporate bond may fluctuate until maturity
Usually caused by changes in interest rates

If interest rates fall, price of bond will increase since its

coupon rate is higher (selling at a premium)

If interest rates rise, price of bond will fall (selling at a

discount)

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Why Investors Purchase Corporate Bonds
(5)
Changes In Bond Value
Approximate Market Value = Dollar Amount of Annual Interest
Comparable Interest Rate

Dollar Amount of Annual Interest = $1,000 × 4.8%

= $48.00

Approximate Market Value = $48.00

5%
= $960
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Why Investors Purchase Corporate Bonds
(6)
Calculating Bond Values

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Why Investors Purchase Corporate Bonds
(7)
Bond Repayment at Maturity
You may keep bond until maturity and then redeem it
You may sell bond at anytime to another investor

 Value of bond closely tied to corporation’s ability to

repay
 Other investors will pay more money for a quality
bond

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Why Investors Purchase Corporate Bonds
(8)
Comparing Bonds to GICs
Bonds included in portfolio to generate steady income,
stabilize returns, and provide security
GIC similar except lending to bank

 Offer better protection as value guaranteed by bank and

insured by CDIC
Bonds higher risk of default therefore higher interest
paid
 Can be sold at market to take advantage of market
fluctuations

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Why Investors Purchase Corporate Bonds
(9)
A Typical Bond Transaction
Bonds are sold through full-service or discount
brokerage firms or the Internet
Bond market is an “over-the-counter” exchange

Bond or investment dealers are paid a fee

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Why Investors Purchase Corporate Bonds
(10)
Assumptions
$1,000 face value, semi-annual, 3 percent interest, 25-year bond maturing on October 7, 2045.
Purchased October 9, 2020; sold October 9, 2027.
Costs When Purchased Cash Flow When
Sold
1 bond @$1,040.31 1 bond @$900.34

Total investment $1,040.31      Dollar return $900.34

Transaction Summary
Dollar return             $    900.34
Minus initial investment              (1,040.31)
Loss from bond sale               (  139.97)
Plus interest ($30 for 7 years)                   210.00
Total return (loss)                $   70.03 22
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Government Bonds and Debt Securities
(1)
Discuss Why Governments Issue Bonds
Types of Bonds
 Government of Canada securities
 Marketable bonds
 Specific maturity date and interest rate and are transferable
 Treasury Bills
 Discounted securities
 Canada Savings Bonds
 Regular or compound interest
 Real Return Bonds
 Pay rate of return adjusted for inflation
 Canada Premium Bonds
 Has higher rate of return than Canada Savings Bonds
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Government Bonds and Debt Securities
(2)
 Federal government sells bonds and securities to
finance national debt and ongoing activities
 Considered low risk investments
 Offer lower interest rates than corporate bonds
 Provincial governments issue bonds to fund program
spending and fund deficits
 Municipal bonds
 Installment Debentures

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Government Bonds and Debt Securities
(3)
Treasury Bills
A Treasury bill, sometimes called a T-bill, is sold in a

minimum unit of $1,000 with additional increments of

$1,000 above the minimum.

T-bills with terms to maturity of 91, 186, or 364 days are

currently auctioned on a bi-weekly basis, generally on
Tuesday for delivery on Thursday.

T-bills are discounted securities, and the actual purchase

price you pay is less than the maturity value of the T-bill. 25
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Government Bonds and Debt Securities
(4)
Treasury Bills
The convention in Canada is to quote T-bills in yield
terms.

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The Decision to Buy or Sell Bonds
(1)
Evaluate Bonds When Making an Investment

Can the corporation, government, or municipality:



 Pay back the face value at maturity?

 Will you receive interest payments until maturity?
Read the annual report
Check the company’s website for more information

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The Decision to Buy or Sell Bonds
(2)
Tesla Corporation Bond Information
Price 97.75
Coupon 5.30%
Maturity Date 8/15/25
Lookup Symbol TSLA4530906

Yield 5.42%
Standard and Poor Rating B-
Payment Frequency Semiannual
First Coupon Date 2/15/18
Type  Corporate
Callable Yes 28
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 The Decision to Buy or Sell Bonds
(3)
1. Price is quoted as a percentage of the face value: $1,000 × 97.75% = $977.50
2. Coupon (%) is the rate of interest: 5.300 percent.
3. Maturity Date is the date when bondholders will receive repayment of the face value: August
15, 2025.
4. Look Up Symbol is the information you can use to determine the current price and other
information about this bond issue on Web sites.
5. Yield (%) is determined by dividing the dollar amount of annual interest by the current price
of the bond: $53 ÷ $977.50 = 0.0542 = 5.42 percent.
6. Standard & Poor’s Rating shows the rating issued by Standard & Poor’s Ratings. This rating
is used to assess the risk associated with this bond: B-.
7. Coupon Payment Frequency tells bondholders how often they will receive interest payments:
semiannually.
8. First Coupon Date tells bondholders when the first interest payment will be paid: February
15, 2018.
9. Type: Corporate.
10. Callable tells the bondholder if the bond is callable or not: yes.

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The Decision to Buy or Sell Bonds
(4)
 Look for signs of financial strengths and weaknesses
 Is firm profitable?
 Are sales revenues increasing?
 Are long term liabilities increasing?
 How is bond rated?
 AAA (the highest) to D (the lowest)
 Junk Bond
 a type of bond that offers a very high return but is very
risky as bond is nearing or currently in default

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 The Decision to Buy or Sell Bonds
(5)
Did you know .

Government of Canada Long-term Credit Ratings are high quality and stable for Canada
Savings Bonds.

Domestic Debt Trend Foreign Debt Trend

Standard & Poor’s AAA AA1
Current Outlook Stable Stable
Moody’s Investors Service Aaa AA1
Current Outlook Stable Stable
Canadian Bond Rating AA1 AA1
Service
Current Outlook Stable Stable
Dominion Bond Rating AAA AA (high)
Service
Current Outlook Stable Stable 31
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 The Decision to Buy or Sell Bonds
(6)
Quality Rating by Description
DBRS
Highest credit quality AAA The capacity for the payment of financial
obligations is exceptionally high and unlikely to
be adversely affected by future events.

Superior credit quality AA The capacity for the payment of financial

Good credit quality
Adequate credit quality
obligations is considered high. Credit quality
differs from AAA only to a small degree.
Unlikely to be significantly vulnerable to future
events.
A The capacity for the payment of financial
obligations is substantial but of lesser credit
quality than AA. May be vulnerable to future
events, but qualifying negative factors are
considered manageable.
BBB The capacity for the payment of financial
obligations is considered acceptable. May be
vulnerable to future events. 32
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The Decision to Buy or Sell Bonds
(7)
Quality
Speculative, non-investment
grade credit quality
Highly speculative credit quality
Very highly speculative credit
quality
Rating by Description
DBRS
BB The capacity for the payment of financial obligations is
uncertain. Vulnerable to future events.
B There is a high level of uncertainty as to the capacity
to meet financial obligations.
CCC In danger of defaulting on financial obligations. There
CC is little difference between these three categories,
C although CC and C ratings are normally applied to
obligations that are seen as highly likely to default, or
subordinated to obligations rated in the CCC to B
range. Obligations in respect of which default has not
technically taken place but is considered inevitable
may be rated in the C category.
D When the issuer has filed under any applicable
bankruptcy, insolvency, or winding up statute or there
is a failure to satisfy an obligation after the exhaustion
of grace periods, a downgrade to D may occur. DBRS
may also use SD (Selective Default) in cases where
only some securities are impacted, such as the case of a
“distressed exchange.”
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The Decision to Buy or Sell Bonds (8)
Bond Yield
Calculations
Current Yield: Dollar Amount of Annual Interest
Current Market Value

Current Yield is the rate of return earned by an

investor who holds a bond for a stated period of
time.

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The Decision to Buy or Sell Bonds (9)
Bond Yield
Calculations
Yield to Maturity: Takes into account the relationship
among the bond’s maturity value, the time to maturity,
the current price, and the dollar amount of interest
Dollar Amount of Annual Interest + Face Value – Market Value
Number of Periods
Market Value + Face Value
2

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The Decision to Buy or Sell Bonds
(10)
 Calculating bond yield

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Summary (1)
LO1 Describe the characteristics of corporate bonds
 A written pledge to repay a specified amount of money
with interest
 All of the details are contained in the bond indenture
 Face value, interest rate, maturity date, repayment
 Trustee is the bondholder’s representative

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Summary (2)
LO2 Discuss why corporations issue bonds
 Help finance their ongoing activities
 Bonds may be debentures, mortgage bonds, subordinated
bonds, or convertible bonds
 To ensure money is available to repay bonds corporations
establish a sinking fund
 Ca also issue serial bonds that mature on different dates

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Summary (3)
LO3 Explain why investors purchase corporate bonds
 For interest income, possible increase in value and
repayment at maturity
 Method used to pay interest depends on how bonds are
registered
 Possible to purchase a bond at a discount and hold it until
is appreciates in value
 Changes in interest rates are prime cause of bond price
fluctuations

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Summary (4)
LO3 Explain why investors purchase corporate bonds
 If you pay too much for a bond and it decreases in value,
you lose money on your investment
 Hold bond until maturity and corporation pays you the
face value
 Bonds can be bought or sold through brokerage firms

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Summary (5)
LO4 Discuss why federal, provincial, and municipal
governments issue bonds and why investors purchase
government bonds
 Federal government sells bonds to finance national debt
and ongoing activities
 Three principal types of bonds
 Treasury Bills, marketable bonds, and Canada Savings
Bonds

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Summary (6)
LO4 Discuss why federal, provincial, and municipal
governments issue bonds and why investors purchase
government bonds
 Provincial and local governments issue bonds to finance
ongoing activities and special projects
 Schools, roads, toll bridges
 Can be purchased through banks, trust companies, other
financial institutions, or through account executives

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Summary (7)
LO5 Evaluate bonds when making an investment
 Newspapers provide information to evaluate a bond issue
 As does a copy of the corporation’s annual report or its
website
 Bonds can be traded online and researched over the
Internet
 Study to rating provided by the CBRS and DBRS

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Summary (8)
LO5 Evaluate bonds when making an investment
 Current Yield is determined by dividing the amount of
annual interest of the bond by its current market value
 The Yield to Maturity takes into account the relationship
among a bond’s maturity value, the time to maturity, the
current price, and the dollar amount of interest

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