How bonds work

Find out what a bondBond A kind of loan you make to the government or a company. They use the money to run their operations. In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. If you sell…+ read full definition is and how these investments earn a return.

When you buy a bond, you’re lending your money to a company or a government (the bond issuerIssuer An organization that offers securities for sale to investors. Examples: corporations, investment trusts and government bodies.+ read full definition) for a set period of time (the termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition). The term can be anywhere from a year or less to as long as 30 years. In return, the issuer pays you interest. On the date the bond becomes due (the maturity dateMaturity date The date when an investment becomes due. On that date, you get your money back without any penalty. Any interest payments stop.+ read full definition), the issuer is supposed to pay back the face valueFace value What you pay to buy a bond or some other investment.+ read full definition of the bond to you in full.

2 ways to make money on bonds

1. Interest payments

With most bonds, you’ll get regular interest payments while you hold the bond. Most bonds have a fixed interest rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition that doesn’t change. Some have floating rates that go up or down over time. On the bond’s maturity date, you’ll get back the face value.

Example – You buy a 10-year Government of Canada bond with a face value of $5,000. The bond pays a fixed interest rate of 4% a year. If you hold the bond until it matures:

• You’ll get back $5,000.
• You’ll get back 4% in interest, or $200, a year.
• Your return will be about $2,000 over 10 years ($200 x 10).

“Floating interest bonds match the interest rate on 3-month T-bills. They pay interest quarterly. If the T-bill rate goes up, you get more interest on your bonds. If the T-bill rate drops, you get less interest.”

2. Selling a bond for more than you paid

In general, when interest rates go down, bond prices go up. If this happens, you can make money by selling your bond before it matures. You’ll get more than you paid for it, and you’ll keep the interest you’ve made up until the time you sell it. Learn more about how interest rates affect bond prices.

Caution

“Savings bonds, such as Canada Savings Bonds, don’t work the same way as other government and corporate bonds. Learn more about savings bonds.”

Bonds can lose money too

You can lose money on a bond if you sell it before the maturity date for less than you paid or if the issuer defaults on their payments. Before you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition, understand the risks.

2 key points

  1. You can make money on a bond from interest payments and by selling it for more than you paid.
  2. You can lose money on a bond if you sell it for less than you paid or the issuer defaults on their payments.
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