When you buy a bond, it’s one piece of a group-funded loan, earning interest with low risk.
When regular people need to borrow money, they take out a loan. But when governments or corporations need to raise funds, they issue bonds.
Bonds work like a voucher, or an I.O.U. Businesses or governments sell bonds to investors to bring in cash as they need it — generally for a specified period of time at a specified interest rate.
They’re also a traditionally safe financial tool to help balance out risk in an investment portfolio: Investors know they’ll get their initial investment back, plus a little interest on top.
There are a few different types of bonds, but experts note they all work in a similar fashion — the business, government agency or local government that needs money issues a batch of bonds.
The issuer sets a term and interest rate for the loan. Once the term or maturity date is reached, the lender gets their investment returned to them along with the interest that money has earned.
How much extra money bondholders will receive depends on the interest, or coupon, rate. The longer a bond’s term, the higher the coupon rate will typically be.
Buying bonds is pretty straightforward. You can either purchase a specific bond or a bond fund (composed of multiple, and sometimes dozens of different bonds) through a brokerage account, on an investing platform or directly from the issuing government agency or corporation.
There are eight different types of bonds:
All eight types of bonds give individual investors an opportunity to take the place of a large lender and provide an organization with the money it needs. In the case of municipal bonds, the cash generated by the bonds is often needed to repair roads, build schools or fund other infrastructure.
The government has similar motivations for issuing Treasury bonds, but on a larger, federal level. Agency bonds fund specific government arms, like Health Canada or the Canada Revenue Agency.
As for corporate bonds, companies rely on these loans to fund large growth initiatives like buying new equipment or properties, for research and development or to increase their workforces.
Convertible bonds, experts note, are a type of corporate bond that holders can exchange for shares of the issuing company.
Junk, or high-yield bonds, are another type of corporate bond. They’re riskier than more traditional bonds but can offer solid returns. That’s because these bonds are issued by corporations that have lower credit ratings from investment services — and that risk can translate into an investor’s reward.
Some of these types of bonds are specific to Canada. If you want to invest in an international company or government, that’s where foreign bonds come in. But foreign entities do issue bonds in the Canadian market — and in Canadian dollars.
Finally, non-conventional bonds, which are fairly uncommon, don’t come with fixed interest rates and maturity dates. Borrowers don’t pay interest every year, instead opting to present it to lenders in a lump sum once the bond reaches maturity.
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