Government bonds
What is a Government Bond?
A government bond is a debt of the federal or provincial government created by borrowing money from investors, usually for a term of one or more years. In return for the loan, the government will pay a fixed rate of interest, called a coupon rate
, on a regular payment schedule.
Governments also issue short term Treasury Bills (T-Bills), usually for a term of less than one year. T-bill yields are usually lower than those of longer term government bonds. T-Bills differ from regular government bonds not just in the length of term and yield but in how they are priced. T-Bills are issued at a discount. You do not receive regular interest during the term. Instead, you receive the face amount of the bond at the end of the term. In this respect, they are like strip bonds but have a much lower risk given their short term.
In addition to regular government bonds and T-Bills, the federal government also sells Canada Savings Bonds (CSBs). We discuss the differences between regular government bonds and CSBs at the end of this section.
What risks do they have?
Government bonds are low risk because the government guarantees to pay interest during the life of the bond, and will repay the principal amount on maturity.
There is a risk that you may receive less than what you paid for a bond if you need to sell it before its maturity date and interest rates have risen.
Another risk is that inflation may rise faster than the bond’s yield. In real dollars, this could cause you to lose money.
You may also find that interest rates are low when you want to to reinvest either the interest or principal.
One way to reduce interest rate risk and reinvestment risk is to purchase bonds with various maturity dates, known as a bond ladder.
Can you sell them easily?
Probably. Governments do not buy back most of their bonds before their maturity date, and these bonds do not trade on an exchange. Instead, your advisor can usually find a buyer for your government bond on the over-the-counter market.
You should talk to your advisor if you are thinking of selling a government bond before its maturity date. If interest rates have risen, you may lose money.
What are the costs?
Generally, your advisor will sell you a bond from the firm’s inventory. If so, the price will contain a mark-up to cover the costs of your advisor’s firm. It’s worth shopping around as this mark-up varies between firms. You can get a sense of the wholesale price for government bonds by referring to various sites that post bond prices. If the yield you are being offered is significantly less than the wholesale yield, you might want to consider a different bond or a different dealer. At the very least, discuss the exent of the difference with your advisor.
If the advisor is acting as your agent and finding a bond in the over-the-counter market, you may also have to pay a commission.
What are the expected types of returns?
Government bonds pay interest, usually more than T-Bills and GICs. You will receive interest on a regular basis until the bond matures, usually every six months or one year. Interest rates are set by the government for the bond’s term. Normally, longer maturity dates come with higher interest rates.
About Canada Savings Bonds
CSBs are different from other government bonds in five important ways:
- You can buy them in smaller amounts, as low as $100
- The government resets the interest rate it pays on the bond every year
- You can cash in your CSBs at face value at any time. This removes the interest rate risk of regular government bonds, but there is still a risk that the return from these bonds may not keep up with inflation
- You can only buy them from October to April
- They normally pay lower rates of interest than other government bonds