Types of Fixed Income

The terms “fixed income” and “bonds” are often used interchangeably but in fact, bonds are only one type of fixed income investment in a family (asset class) which includes guaranteed investment certificates (GICs), and money market securities. Typically, these products generate a predictable stream of interest income and/or promise of a future lump sum payment and can be a great way to achieve diversification in your portfolio.

There are many different types of fixed income securities, each with its own set of considerations for investors. Here we touch on a few:

Bonds

What are they?

A bond is a loan made by an investor to an issuer. In turn, the issuer promises to pay the investor a specified rate of interest (the coupon) usually every six months and repay the principal (or face value) of the bond at a future maturity date. The major issuers of bonds are governments and corporations.

Interested in learning more about how bonds work? Read Fixed Income Basics.

There are a number of different types of bonds for investors to choose from, including:

Government of Canada Bonds
Provincial Bonds
Municipal Bonds
Investment-Grade Corporate Bonds
High-Yield Bonds
Strip Coupons and Residual Bonds

Government, Provincial and Municipal Bonds

Federal, provincial and municipal governments issue bonds to fund deficits or to raise capital for program spending. Generally, maturity terms range from over two to 30 years and interest is payable on a semi-annual basis. The most highly traded bond issues have terms of five, 10, and 30 years.

Government of Canada (GOC) Bonds

AAA rating
Highest credit quality and most conservative bond available in Canada
Guaranteed by the federal government

Provincial Bonds

Vary in credit rating depending on the province's power of taxation and the creditworthiness of the debt
Have higher yields than GOC bonds
Guaranteed by issuing province

Municipal Bonds

Vary in credit rating depending on the municipality's power of taxation and the creditworthiness of the debt
May have higher or lower yields than provincial issues of the same quality, depending on specific issues and liquidity
Not automatically guaranteed by the provinces in which they operate

Investment-Grade Corporate Bonds

Corporate bonds are debts issued by companies to raise capital to finance operations and projects. Companies that issue debt are given a rating based on their financial strength, future prospects and past history. Investment-grade bonds must be rated "BBB-" or “Baa3” or higher by credit rating agencies Standard & Poor's or Moody's. Corporate bonds are riskier than government bonds and usually have a higher risk of default. However, the increased risk generally comes with higher returns than “safer” government bonds. Liquidity varies depending on the issuer.

High-Yield Bonds

Bonds with a credit rating below “BBB-" for S&P or “Baa3” for Moody’s are considered non-investment grade. These bonds are often called high-yield or junk grade because they are riskier and their ability to repay issued debt is more uncertain. It is always important to assess these bonds carefully and to consider the risks. There is a higher potential for capital loss rather than if you were to invest in a bond of higher-quality.

Strip Coupons and Residual Bonds

Coupons are created from federal, provincial, or municipal bonds whose two basic components — the semi-annual interest payments (coupons) and the principal amount (the residual) — are separated and sold as individual securities. These instruments are purchased at a discount and mature at par ($100). Generally, the longer the term to maturity, the greater the discount.

Coupons and residuals pay no interest until maturity and entitle the holder to the security's full face value at maturity. The interest compounds annually at the yield to maturity at the time of purchase. For example, a Canadian strip coupon maturing in five years with a yield of 6% would be priced at $74.72 and mature at $100. Although no money is paid out until maturity, the interest on the bond accrues each year and must be included as income on income tax records annually.

Compared with conventional bonds, strip coupons eliminate reinvestment risk over the term of the investment by paying no cash flows until maturity. Coupons may offer higher yields than bonds but its price may fluctuate more than a bond of similar term and credit quality.

Coupons offer investors safety (most are government or high-quality corporate-backed), and an attractive guaranteed yield if held to maturity. Strip coupons remain a popular choice for tax-sheltered accounts such as RRSPs and RRIFs.

Guaranteed Investment Certificates

A Guaranteed Investment Certificate (GIC) is a deposit investment issued by financial institutions such as chartered banks, trust companies and mortgage and loan companies. GICs offer a specified rate of return for a set period.

Many GICs are guaranteed by the Canada Deposit Insurance Corporation (CDIC) for up to $100,000 (this includes both principal and interest), provided that certain criteria are met. Each individual issuer can provide full CDIC coverage, which means that you could invest, for example, $400,000 with four different issuers - all completely CDIC insured and in one account.

Risk/return

GICs have historically offered a return slightly higher than the return on treasury bills (T-bills). They are popular among investors because the investment is considered safe and fully guaranteed up to the CDIC limit, providing it meets specified criteria.

Choice

As an RBC Direct Investing client, you have access to GICs from a large selection of financial institutions.

Minimum investment amount

The minimum initial investment depends on the term but starts at $3,500 par value for registered accounts, $15,000 for non-registered accounts. Par value is the principal value, or the amount at which a security is issued and redeemed at maturity, not including interest.

Income

With the ability to invest in GICs that offer annual, semi-annual, monthly or compound interest, you may be able to match your investment needs while supplementing your income.

Money Market Products

Money market products such as treasury bills (T-bills), commercial paper and banker's acceptances are short-term fixed income products that are sold at a discount and mature at par (face value). The difference between your purchase price and par value is your return.

Treasury Bills (T-Bills)

What are they?

T-Bills are short-term debt instruments issued by federal and provincial governments. Fully backed by the applicable government issuer, a high level of security makes T-Bills a popular investment for individual, institutional, and corporate investors.

Term/Liquidity

T-bills have a maximum maturity of one year and are issued in terms of 30-, 60- or 90 days, six months or one year. They are highly liquid and many investors choose to hold them instead of cash. They can be sold at any time.

Risk/Return

T-bills are considered very safe because they are fully guaranteed by the issuing government; however, they offer considerably lower potential returns than most other securities.

Minimum Investment Amount

The minimum par value for purchasing a T-bill is $10,000, trading in increments of $1,000.

Income

The difference between your purchase price and par value is your return. This is considered interest income.

Banker's Acceptances (BAs)

What are they?

BAs are short-term credit investments created by a borrower for payment on a specified future date. BAs are "accepted" or guaranteed at maturity by banks and offer a high degree of safety for short-term investors.

Term/Liquidity

Banker’s acceptances are usually issued in one to three-month periods and are highly liquid.

Risk/Return

The yield to maturity (rate of return) of a BA can be attractive compared to other short-term investments. BAs provide a slightly higher rate of return versus T-bills due to their comparatively lower credit quality.

Minimum Investment Amount

The minimum initial investment at RBC Direct Investing is $50,000 par value, trading in increments of $1,000.

Income

The difference between your purchase price and par value is your return. This is considered interest income.

Commercial Paper (CP)

What is it?

CP investments are unsecured promissory notes issued by corporations. Companies issue CP to finance seasonal cash flow and working capital needs at lower rates than conventional bank loans.

Term/Liquidity

CP is typically issued in one-, two- and three-month terms, but may be issued for any term from one day to one year. CP is highly liquid and may be sold at any time.

Risk/Return

Investors buy CP because it usually provides the highest return compared to other short-term alternatives, such as T-bills or BAs. Investments in CP are considered relatively secure for a variety of reasons. First and foremost, companies issuing the notes are generally large and mature. In addition, most CP sold by RBC Direct Investing hold a rating from one of the major Canadian ratings agencies in the R1 grade (investment grade) category.

Minimum Investment Amount

The minimum initial investment at RBC Direct Investing is $100,000 par value, trading in increments of $1,000.

Income

The difference between your purchase price and par value is your return. This is considered interest income.

Crown Corporate Paper

What is it?

Crown corporations are state-owned enterprises owned by the Sovereign of Canada. Short-term promissory notes are issued by crown corporations such as the Canadian Mortgage and Housing Corporation, Federal Business Development Bank, Export Development Corporation or Canadian Wheat Board. Many crown corporations issue commercial paper denominated in both Canadian and U.S. dollars.

Term/Liquidity

Crown corporate paper is highly liquid. It can easily be sold at market value prior to maturity and is available in terms of one month to one year.

Risk/Return

Crown corporate paper is fully guaranteed by the Government of Canada and offers the same high quality as Government of Canada T-bills, but pays a slightly higher rate of return.

Minimum Investment Amount

When available in inventory, the minimum initial investment is $100,000 par value.

Income

The difference between your purchase price and par value is your return. This is considered interest income.

Another way to gain exposure to fixed income is by purchasing Mutual Funds or Exchange Traded Funds (ETFs)

What are they?

Mutual Funds and Exchange Traded Funds (ETFs) are pooled investment vehicles that have important differences, but they may offer the following advantages over portfolios composed of individual fixed income securities:

Convenience: Widely available, easy to buy and sell and provide convenient exposure to the bond market.
Diversification: Fund managers can diversify by type, sector, credit quality and maturity more easily, as they have access to larger pools of capital.
Active management: Can be actively managed by professionals, allowing for ongoing participation in the market. This can reduce the impact of fluctuating interest rates.
Liquidity: These funds are liquid investments and generally allow for easy reinvestment.

Mutual Funds and ETFs also invest in money market instruments, bonds and other fixed income securities.

Looking for more information?

When you know which kind of product best suits your needs, use the Fixed Income Screener or Mutual Fund Screener or ETF Screener to help with your search.

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The information provided in this article is for general purposes only and does not constitute personal financial advice. Please consult with your own professional advisor to discuss your specific financial and tax needs.

RBC Direct Investing Inc. and Royal Bank of Canada are separate corporate entities which are affiliated. RBC Direct Investing Inc. is a wholly owned subsidiary of Royal Bank of Canada and is a Member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. Royal Bank of Canada and certain of its issuers are related to RBC Direct Investing Inc. RBC Direct Investing Inc. does not provide investment advice or recommendations regarding the purchase or sale of any securities. Investors are responsible for their own investment decisions. RBC Direct Investing is a business name used by RBC Direct Investing Inc. ® / ™ Trademark(s) of Royal Bank of Canada. RBC and Royal Bank are registered trademarks of Royal Bank of Canada. Used under licence.

There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Please read the prospectus or Fund Facts before investing. Mutual funds are not guaranteed or covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer, their values change frequently and past performance may not be repeated. For money market funds there can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you.