Bonds -- essentially promises to pay back borrowed money with interest -- are popular investment vehicles because they provide somewhat more safety than stocks, along with regular interest payments. They are therefore very useful for structuring investment portfolios to generate income, and for balancing a stock-heavy portfolio. Canadian corporate bonds don't have the same safety of capital as Canadian savings bonds and other Canadian government obligations -- but tend to pay a higher interest rate to compensate for their greater risk.
An important consideration in bond selection is the ability of the company to make good on its obligations to bondholders -- even if it suffers a severe business setback. To ensure the safety of capital, you may wish to examine company financials to ensure that the bond issuer's debt load is not excessive, that it has reserves on hand, or that it has enough assets to pay off bondholders if managers suddenly had to liquidate the company. That is, it should have a positive book value, or more assets on hand than liabilities.
Some bonds are riskier than others. If you see a bond that offers a substantially higher interest rate than other bonds from comparable companies, it is often because that company's prospects are less certain. Some bond brokers specialize in a special segment of speculative bonds, called "high-yield" bonds, or "junk bonds." Interest rates are higher, but so is the risk of default, and bond prices can be very vulnerable. Other bonds have higher ratings of A or better from Moody's, Standard & Poors or Fitch Ratings. These bonds are called "investment grade" bonds, and they offer greater stability, but lower yields.
Buying Bonds in Canada
The Canadian government closely regulates who can sell securities, including bonds. Look for a registered investment dealer. This is someone who has passed a background check and a series of extremely challenging examinations. You can verify a broker's credentials by going to the Investment Industry Regulation Organization of Canada, which is also the licensing authority for securities dealers.
If you have limited capital, or you do not want to select individual bonds, you may consider a mutual fund that focuses on Canadian corporate bonds. Their advantages include simplicity and instant diversification: You can own a piece of hundreds of different bonds with a single transaction. However, there are no guarantees on interest payments from these funds. You could find your expected yield drop sharply if interest rates fall, because bonds in fund portfolios are constantly maturing or getting sold out of the portfolio, and the fund has to reinvest at lower interest rates. Funds can also be expensive, charging a percentage of fund assets to pay fund and manager expenses. These fees can add up over time.
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