Bond definition

Bonds are debt securities issued by governments and corporations,including companies, to raise money. It’s essentially a way for governments and corporations to borrow money directly from investors. Bonds can have both fixed and variable rates of return and some government issued bonds are 100% guaranteed.

How do bonds work?

When you purchase a bond, you’re agreeing to loan a certain amount of money to a government or corporation for a certain amount of time. In exchange, that government or corporation agrees to pay back 100% of what they borrowed, plus the stated interest.

Some bonds are guaranteed by the government while others can be high risk so the level of risk can vary. Returns on guaranteed bonds are typically lower, while returns on high-risk bonds are typically higher. All bonds carry credit and default risk since they are tied to the issuer's financial viability. If a company (or government) struggles financially, investors are at risk of default on the bond. In other words, the bondholder may lose 100% of the principal invested should the underlying company file bankruptcy. Which type of bond is best for you will depend on how much risk you’re willing to accept in exchange for higher potential returns.

There are lots of different types of bonds to choose from.

Government of Canada bonds: These bonds are issued by the federal government. Government of Canada bonds are considered the highest quality and most secure bonds available.

Provincial bonds: These bonds are issued by provincial governments. Provincial bonds aren’t as secure as Government of Canada Bonds, but often offer higher rates of return.

Municipal bonds: These bonds are issued by municipal governments. Rates offered by municipal governments can sometimes be higher or lower than rates associated with provincial bonds.

Investment-grade corporate bonds: Bonds issued by corporations with a rating of “BBB- “or “Baa3” or higher are considered investment-grade bonds. Corporate bonds are of higher risk than government bonds but tend to offer a higher rate of return.

High-yield bonds: Bonds issued by corporations with a rating below “BBB- “or “Baa3” are called high-yield bonds. These bonds often offer a high rate of return but are much higher risk than investment grade or government-issued bonds. Because they are relatively high-risk, these bonds are sometimes referred to as junk bonds.

Strip coupons and residual bonds: Bonds include two parts: interest payments and the principal (the face value of the bond). When you invest in a typical bond, you own both parts. You’ll receive interest payments at predetermined intervals, and the principal will be returned to you when the bond matures.

Investment firms sometimes separate these two parts – strip coupons and residual bonds – and sell them individually. If you buy a strip coupon, you’ll receive the predetermined interest payments associated with a given bond. If you buy the residual bond, you’ll receive payments equal to the principal amount.

Canada Savings Bond (CSB): CSBs are a type of bond guaranteed by the federal government.

CSBs are purchased through a payroll savings program and provide a guaranteed rate of return. CSBs can’t be traded on the secondary market and only return your principal investment on maturity.

You’ll periodically receive interest payments from compound-interest CSBs but will need to report those payments as income each year.

Unfortunately, CSBs are no longer available for purchase.

Bonds can provide a range of benefits, including: 

• Reliable income payments: The regular interest payments provided by bonds can give investors a steady source of income.
• Low risk: Government-issued bonds and investment-grade bonds are considered low-risk investments.
• Diversification: You can now use bond ETFs to purchase a variety of bonds at a single price.    

While bonds are relatively low risk, no investment is 100% risk free. Risks associated with bonds include:

• Low interest rates: Bonds typically provide relatively low rates of return. Interest rates can be higher for longer-term, or higher risk bonds, but may still be less than other investment products.
• Hard to keep up with inflation: High rates of inflation can reduce the value of any interest payments you earn. For example, if a bond pays a 4% interest, but inflation is 3%, the bond's real rate of return is only 1% when adjusted for inflation.  

What is the main risk of owning bonds?

There’s always some risk that the bond issuer will default on their payments. That risk is relatively low when purchasing government issued and investment-grade corporate bonds, but it’s still a risk.

Can you sell bonds whenever you want?

Yes. You can always sell a bond on the secondary market before it matures. However, it’ll cost you. Bond sales may be subject to certain commissions or “markdowns” charged by brokers to cover the cost of selling the bond on your behalf.

Do you pay taxes on bonds?

Yes. One of the main benefits of bonds is that they can provide investors with a reliable source of income. However, you’ll need to claim that income on your annual income tax return, and any earnings will be taxed at your marginal income tax rate.

Do bonds generate interest income or capital gains?

Bonds can generate interest income and capital gains or losses depending on how interest rates change.

Bonds provide investors with regular interest payments. These payments are treated as income and taxed accordingly in the year that the interest payments are received.

The value of existing bonds tends to go up when interest rates go down, and down when interest rates go up. If interest rates go down, you may be able to sell your bond for more than you paid for it. Any profits gained from reselling bonds on the secondary market will be subject to capital gains. However, if interest rates go up, you may only be able to sell your bond at a discount. If you do, the sale of that bond would constitute a capital loss and make you eligible for certain tax benefits.

What are the different types of bonds?

There are several types of bonds available to investors, each offering different levels of risk and return. Common categories include:

• Government of Canada bonds: Issued by the federal government and considered among the safest investments.
• Provincial and municipal bonds: Issued by local governments and may offer slightly higher returns than federal bonds, with varying levels of risk.
• Corporate bonds: Issued by companies and typically divided into:
  • Investment-grade bonds (lower risk, lower returns)
  • High-yield bonds (higher risk, higher potential returns)
• Strip coupons and residual bonds: Components of traditional bonds that are separated and sold individually, focusing on either interest payments or principal.

Bond funds and ETFs: Pooled investments that provide exposure to multiple bonds in a single purchase, offering diversification and ease of access.

Each type of bond comes with its own risk profile, income potential, and investment strategy considerations, so the right choice depends on your financial goals and risk tolerance.

How do I buy bonds in Canada?

You can buy bonds in Canada through a few different methods, depending on the type of investment you’re looking for:

• Through an online brokerage (such as TD Direct Investing):
  You can purchase individual bonds, bond ETFs, or bond mutual funds directly from your investment account 
• Through a financial advisor or broker:
  Advisors can help you access new issue bonds or find specific bonds on the secondary market, though commissions may apply.
• Directly from governments or institutions:
  Some government bonds may be available through financial institutions, though many are now primarily accessed via brokers.
• By investing in bond ETFs or mutual funds:
  This is often the easiest option for beginners. You get exposure to a diversified portfolio of bonds with a single purchase.

In practice, most investors today buy bonds through a brokerage account, either as individual bonds or, more commonly, through ETFs or mutual funds for simplicity and diversification.

To learn more about buying bonds in Canada, click here.

What's a 5-year Canadian bond yield?

A 5-year Canadian bond yield refers to the annual return an investor earns from holding a 5-year Government of Canada bond, typically expressed as a percentage.

It represents:

• The interest rate the government pays to borrow money for 5 years
• The return investors receive if they hold the bond to maturity

This yield is closely watched because it:

• Acts as a benchmark for interest rates in Canada
• Influences things like fixed mortgage rates, loans, and savings products
• Reflects market expectations around inflation and economic conditions

For example, if the 5-year bond yield is 3.5%, an investor would earn roughly 3.5% annually by holding that bond to maturity, assuming no changes.

It’s important to note that bond yields fluctuate daily based on market conditions, including central bank policy from the Bank of Canada, inflation expectations, and overall demand for government debt.

What is a 10-year Treasury yield?

The 10-year Treasury yield is the annual return investors earn from holding a 10-year U.S. government bond (Treasury note) to maturity.

Issued by the U.S. Department of the Treasury, it represents:

• The interest rate the U.S. government pays to borrow money for 10 years
• A benchmark rate that influences borrowing costs across the economy

The 10-year Treasury yield is widely followed because it affects:

• Mortgage rates
• Business and consumer loan rates
• Stock market valuations
• Global financial conditions

Yields move up or down based on factors like inflation expectations, economic growth, and monetary policy. For example, if investors expect higher inflation, yields typically rise to compensate for reduced purchasing power.

In short, it’s one of the most important indicators of overall economic sentiment and interest rate trends.

What is the 10-year bond rate?

In Canada, the 10-year bond rate typically refers to the yield on a 10-year Government of Canada bond, issued by the Government of Canada.

It represents:

• The annual return investors earn for lending money to the federal government for 10 years
• A key benchmark interest rate used across the Canadian economy

The 10-year bond rate is closely watched because it influences:

• Fixed mortgage rates
• Business and consumer lending rates
• Investment decisions and portfolio returns
• Overall economic sentiment

This rate moves daily based on factors like inflation expectations, economic growth, and decisions from the Bank of Canada.

Buying bonds can be a relatively safe way to invest, determine your risk profile prior to investing your money. When you buy a bond, you agree to loan your money to a government or corporation for a specific period of time. In exchange, that government or corporation agrees to pay back your principal investment, plus interest. The amount of interest you earn will typically depend on the type and duration of bond you choose to buy.

TD Direct Investing can make it easy to add bonds to your investment portfolio. Open an online account today to help achieve your savings goals.