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The Money Management Newsletter: GICs and Fixed Income
Look into Government Bonds

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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