Bonds, Duration & Interest Rates: Master Fixed Income for the CIRE Exam

Bond Fundamentals

A bond is a debt instrument. The investor is the lender; the issuer (government or corporation) is the borrower.

Key Terms

• Par Value (Face Value): Usually $1,000—the amount repaid at maturity
• Coupon Rate: Fixed percentage paid as interest annually (usually semi-annually)
• Maturity: The date when principal is repaid

Example: A $1,000 bond with a 5% coupon pays $50/year ($25 every 6 months).

The Inverse Relationship: Bond Prices & Interest Rates

This is the most critical concept in fixed income.

• Rates UP → Prices DOWN: If new bonds pay 6%, nobody wants your old 4% bond unless you lower the price (discount)
• Rates DOWN → Prices UP: If new bonds pay 2%, your old 4% bond is valuable (premium)

Yield to Maturity (YTM)

The total return expected if the bond is held until maturity.

• Includes coupon payments PLUS capital gain/loss
• Allows comparison of bonds with different coupons and prices
• The "true" yield measure for comparison shopping

Duration: Measuring Interest Rate Risk

Duration measures a bond's price sensitivity to interest rate changes, expressed in years.

The Rule: Higher duration = more price volatility when rates change.

Factors That Increase Duration:

• Long time to maturity (30-year vs. 5-year bond)
• Low coupon rate (or zero coupon)
• Low yield environment

Bond Types for the CIRE Exam

Government of Canada Bonds

• Credit Risk: Virtually zero (backed by federal taxing power)
• Treasury Bills: Maturity <1 year, sold at discount, no coupons
• Marketable Bonds: Maturity >1 year, semi-annual coupons
• Liquidity: Extremely high—easiest to sell quickly

Corporate Bonds

• Credit Risk: Risk the company defaults
• Investment Grade: BBB or higher—suitable for conservative portfolios
• Credit Spread: Higher yield than government bonds to compensate for risk

High Yield (Junk) Bonds

• Rating: BB or lower
• Risk/Return: High default risk but significantly higher coupons
• Behavior: Often move more like stocks than safe bonds

Special Bond Features

Callable Bonds

• Issuer can repay early (usually at slight premium)
• Creates Reinvestment Risk for investors
• Companies call bonds when rates drop to refinance cheaper

Convertible Bonds

• Can be exchanged for common shares at holder's option
• Offers bond safety with stock upside potential
• Lower coupon rate than standard bonds (pays for the conversion feature)

Strip Bonds

• Zero-coupon bonds sold at deep discount
• Buy at $600, receive $1,000 at maturity
• Tax Trap: Must report "accreted interest" annually even with no cash received
• Best held in: Registered accounts (RRSP/TFSA)

Bond Pricing Exam Tips

• If coupon rate > market yield → Bond trades at a PREMIUM (above $1,000)
• If coupon rate < market yield → Bond trades at a DISCOUNT (below $1,000)
• If coupon rate = market yield → Bond trades at PAR ($1,000)