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BONDS AND DEBENTURES

 

A Bond or Debenture are fixed-income instruments that represents a loan made by an investor to a borrower (typically corporate or governmental).  In the case of Bonds and Debentures these terms may be used interchangeably but are distinctly different, bonds are essentially loans secured by a specific physical asset.A debenture is a debt security issued by a corporation not secured by assets but by the Credit rating of the organization. Both could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. 

Typically, the investor agrees to invest for a specific period of time, at a set rate of interest. There are exceptions in both duration and interest rate. As an example an issuer of a debenture could tie the interest paid to the fluctuating rate of inflation. All terms form part of the contractual obligations and are known at time of issuance by the government or corporation to the lender. 

Strictly speaking a Government Bond is a debenture and is based upon the credit worthiness of the issuing government. Government of Canada Bonds offer attractive returns and are fully guaranteed by the federal government. They are available for terms of one to 30 years and like T-Bills, are essentially risk-free if held to maturity. They are considered the safest Canadian investment available with a term over one year. 

Bonds can complement an existing portfolio by adding diversification and help cushion it against major losses if the stock market drops. While bonds are typically lower risk investments, there still remains an amount of risk associated with them. The most common is interest rate risk. When interest rates rise, market values of outstanding bonds fall, and vice versa. Bondholders may have to sell existing bonds at a discount if they want to purchase new bonds. Another risk is default risk, the risk that the bond issuer will be unable to pay interest or principal. Credit rating agencies were established to assess the default risk of certain bonds through the study of all information provided to the public, and to rate the bonds by assigning “grades” to the bonds and issuing company. 

A bond rating is a grade given to bonds that indicates their credit quality. Independent rating services such as Standard & Poor’s and Moody’s provide these evaluations of a bond issuer’s financial strength, or its ability to pay a bond’s principal and interest in a timely fashion. Bond ratings are expressed as letters ranging from “AAA”, which is the highest grade, to “D”, which is the lowest grade. Different rating services use the same letter grades but use various combinations of upper- and lower-case letters and modifiers to differentiate themselves. Standard & Poor’s rates some 2,000 domestic and foreign companies; 8,000 municipal, state, and supranational entities; and 1,300 commercial paper-issuing entities. Moody’s rates 19,000 long-term debt issues; 28,000 municipals; and 2,000 commercial paper issuers. 

We no longer directly offer bonds through our investment facilities. We have transitioned to a Managed ETF model. We have found the reduced costs, flexibility, and broad diversification available through ETF’s have enhanced our client’s financial well-being. 

 

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