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 The
Money Management Newsletter: GICs
and Fixed Income
Look into Government Bonds
Money Management Newsletter - November 1996
Many clients have asked about advertisements
for Government Bonds that offer higher (8% when article published) yields
in a current market where 5 year bank GIC rates are under 6.5% and Trust
Company rates average around 6.75%. (View
current rates) The question usually is whether or not the bonds would
be a good buy for them.
The suitability of the bond purchase will depend on
a number of factors:
1. is the buyer looking for an income producing investment
that they will hold to maturity or are they a trader looking for short
term capital gains expecting interest rates to fall? If the intention
is to buy the bond and hold it then the following points must also be
considered.
2. is the purchase for an RRSP account or a non RRSP
account? If it is for a non RRSP account the after tax implications
of the purchase must also be considered
3. what is the price of the bond? Can it be purchased
for a discount or is there a premium on the price? For example a price
of $112 means that for every $100 of bond face value the cost is $112.
In this case a bond with a face value of $20,000 would cost $22,400.
This is important because the buyer will only receive the $20,000 face
amount back at maturity and the $2,400 extra is a cost that must be
factored in when looking at after tax analysis of the purchase.
4. What is the bonds coupon rate? This rate determines
the annual amount of income produced by the bond and in the case of
a non RRSP purchase the amount on which tax must be paid. A coupon rate
of 9.50% means that no matter what price is paid for the bond or what
the promised yield is, that bond will always pay $95.00 for every $1,000.00
of face value. In our $20,000 purchase example this would mean annual
taxable income of $1,900.00.
5. What is the remaining term of the bond? This will
allow you to compare it to other fixed term investments. Also the longer
the term of the bond the more its market value will change with fluctuations
in interest rates.
 This
is not an issue if the intent is to hold it to maturity however it is
a consideration if a forced sale is required. (i.e. for estate purposes)
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