Understanding Bonds versus Guaranteed Bank Deposits referred to as GIC’s or CD’s
Anything that is a bond or treasury bill has a guaranteed maturity regardless of the day-to-day pricing in a brokerage account. At times there can be anomalies in the daily pricing of bonds for reasons that are mostly irrelevant when understanding the bigger picture of bonds maturing at full face value.
For example, bonds are priced daily at the end of the trading day at what is called the “Closing bid”. This “bid” price is the highest bidding price the last bond trader who had an order that day were willing to pay for that particular bond and that is what the pricing system uses for the current market value of that day. It can be a low number (we refer to them as “Stink bids) as all the other traders with the more realistic market value bids had pulled their “bids” for the day and that “Stink bid” was the only one left at the close. That is what gets picked up by the system, thus reflecting an unusually low market value for that bond on that day. This is an unusual occurrence, but it can happen occasionally.
Just remember with a bond portfolio, the principal objective is to generate low risk interest income and in an actively managed bond portfolio to generate some capital gains as well.
In the end, regardless of the day-to-day market pricing, all bonds mature on their specified maturity date at their full-face value as stated on the bond.
Sometimes we buy bonds at a “deep discount” to the maturity value to take advantage of the returns coming from capital gains (tax efficient) rather than from the bond interest.
If you own bonds and you look through your bond holdings and compared the face / maturity values to the current market value (based on the bid) you may see that they are priced lower today than what they will mature at, and possibly lower even than what was paid for them.
In the end, when a bond matures it matures at full face value and from the time we buy and the time it matures, the pricing can fluctuate, however the bond market value always wiggles it way higher toward the maturity face value.
With bonds the interest and / or capital gain on the bond is what determines the bond’s overall “Yield to Maturity” and that is set at the time of purchase. So regardless of what happens between the time it is bought and the day it matures is simply a reflection of the current day’s value if the bond were to be sold.
A GIC or in the USA a CD, is a “bank deposit product” not a bond.
Basically, a GIC is fixed term deposit with a stated interest rate.
The “Bid” shown in a brokerage account is always the same from the day it’s bought to the day it matures. Priced at 100.00 or 100% of the face value of the deposit.
A $10,000 GIC always shows the price at 100.00 or $10,000.
The reason is that it is a fixed bank deposit and can never be sold prior to its maturity date. So through its lifetime, the money is locked in and cannot be withdrawn until the date it matures. That is why GIC’s are always priced at face value as there is no “secondary market” and no one can bid on it, like a bond.
A Bond is a living creature with an aftermarket where it can be sold and bought again after its issuance.
The pricing of the bond’s “bid” can fluctuate throughout its life until the day it matures at full face value or 100.00 %.
That daily market value or the “bid” can vary in magnitude based on the interest rate on, how many years remaining before maturity and what the current market rates of interest do over the same time period.
If you buy a 10-year bond and after your purchase, the interest rates for any newly issued 10-year bonds go higher, the bid for the previous issued bond will decline to reflect an adjustment to the current market’s interest rates.
If the market interest rates go lower, the bid for the previously issued bond will go higher. It’s like a teeter totter. On one end is the bond’s value (bid) of the day and on the other end is the current interest rate environment of the day. Current rates go higher - bond bid goes lower. Current rates go lower - bond bid goes higher.
All this in the end is irrelevant if the bond is held to its maturity date where it will mature at its full face value or 100.00%.
Summary:
In the world of owning bonds versus bank deposits, one needs to understand the differences and the mechanics of how the day-to-day pricing of bonds is done and what it means to your portfolio’s current market value over time.
The daily value of any bond portfolio is merely a reflection of the moment, and what the bond portfolio would be valued on that day.
Where this becomes relevant is when there is a need to determine an accounts value on any particular day- for example, at year-end for accounting purposes, or more often if the account holder died and their estate had to value the deceased’s assets on the date of death.
Other than this, the value of a bond portfolio is merely a reflection of the moment and should be understood as just that.
Once a person can get their head around how daily bond pricing works, it will help understand what causes any daily changes in a bond’s price and what it means to them.
Rule of thumb is to always focus on the face / maturity values of the bonds owned, as the core objective for owning bonds. Daily or month-end account pricing provides a snapshot of the bond or the bond portfolio value of that moment.
If anyone would like to discuss this topic or anything else, please let us know.
Stephen Bishop
Information in this article is from sources believed to be reliable, however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, Stephen Bishop, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member Canadian Investor Protection Fund.
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