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The following frequently asked questions provide a brief introduction
to fixed-income securities:
What are fixed-income securities?
A fixed-income security is a debt instrument issued by a
government, corporation or other entity to finance and expand
their operations.
Fixed-income securities provide investors a return in the
form of fixed periodic payments and eventual return of principal
at maturity. The purchase of a bond, treasury bill, Guaranteed
Investment Certificate (GIC), mortgage, preferred share or any
other fixed-income product represents a loan by the investor to
the issuer.
Why invest in fixed-income securities?
Fixed-income securities can be an important part of a well-diversified
portfolio. For many investors, particularly retirees, fixed-income
investments are a secure, low-risk way to generate a steady flow
of income. As long as they are held to maturity, fixed-income securities
will provide a guaranteed return on your investment, with payments
known in advance.
What are some examples of fixed-income
securities?
The following is a list of some common fixed-income securities:
- Bonds
A bond is an obligation or loan made by an investor to an issuer
(e.g. a government or a company). In turn, the issuer promises to
repay the principal (or face value) of the bond on a fixed maturity
date and to make regularly scheduled interest payments (usually
every six months). The major issuers of bonds are governments and
corporations.
- Savings Bonds
Savings bonds issued by the Canadian and various provincial
governments are different from conventional bonds. Canada Savings
Bonds (CSBs) typically pay a minimum guaranteed interest rate
(there are also compound interest bonds available). A CSB carries no
fees and is cashable at any time. The amount received for a CSB
will never go below its face value if redeemed by the issuer,
while the price received in the market for a conventional bond will
depend on the level of interest rates at the time of sale. In addition,
only residents of Canada (or of the province of issue) are eligible
to purchase CSBs, and only up to a predetermined amount.
- Guaranteed Investment Certificates (GICs)
A GIC is a note issued by a trust company with a fixed yield and term.
The Canada Deposit Insurance Corporation (CDIC) insures many GICs for
interest and principal totaling up to $100,000. GICs are generally non-redeemable before the term is complete.
- Treasury Bills
Treasury bills (T-bills) are the safest type of short-term debt
instrument issued by a federal government. Ideal for investors seeking
a 1- to 12- month investment period, T-bills are highly liquid
and very secure.
- Banker’s Acceptances
Banker’s Acceptances (BAs) are short-term promissory notes issued
by a corporation, bearing the unconditional guarantee (acceptance) of
a major Chartered Bank. BAs offer yields superior to T-bills, and a
higher quality and liquidity than most commercial paper issues.
- NHA Mortgage-Backed Securities (MBS)
A National Housing Act (NHA) MBS is an investment that combines the
features of residential mortgages and Canadian government bonds.
MBS investors receive monthly income consisting of a blend of
principal and interest payments from a pool of mortgages.
- Strip Coupons and Residuals
Strip coupons and residuals are instruments purchased at a discount
that mature at par (100). They grow over time and while any interest
income is not payable until maturity, a nominal amount of interest
is accrued each year and must be claimed as income by the purchaser
for tax purposes. For example, a Canada strip coupon maturing on
March 15, 2006 with a yield of 5.31% would be priced at 77.07 to
mature at 100. The difference between the purchase price and 100 is
treated as interest income.
Strip coupons generally offer higher yields and can also fluctuate
more than the price of a bond of similar terms and credit quality.
All of the aforementioned features make strip coupons a popular
choice for tax-sheltered accounts such as Retirement Savings Plans
(RSPs) and Retirement Income Funds (RIFs).
- Laddered Portfolio
A laddered portfolio is comprised of several bonds, each of which
has a successively longer term to maturity. Each position in the
portfolio is usually the same size as the next, with intervals
between maturity dates roughly equal. A laddered portfolio helps
spread reinvestment risk over the long term, helping to average
out the effects of overall interest rate changes.
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