Overview of the Canadian Fixed Income Capital Market

The Canadian fixed-income capital market is essentially a wholesale market where trading is completed (mainly by institutional investors, for example, pension funds). The market is a sub-sector of the capital market.

 A capital market is a financial investment market where investors can purchase and sell securities, for example debt and/or equity.

Also called a bond market, the fixed-income market consists of a diverse array of long-term borrowing instruments. For example, terms for these instruments are much longer than those that trade in the money-market. www.helium.com/…/1877204-an-overview-of-the-canadian-money-market)

Governments, corporations, and/or other business entities frequently issue these long-term, fixed-rate debt instruments to finance operations, cover budget deficits and expenditures.

Known as fixed-income securities, these offer investors a monetary return in the form of preset payments, with repayment of principal at fixed maturity date. Although instruments in the fixed-income market are long-term, they can also be quite risky.

To enter into a transaction, a potential investor must contact dealers who are active in the market, trading with the one quoting the best price. Dealers maintain an inventory of securities, buying and/or selling at the quoted rate.

The purchase of such a security represents a loan by the investor to the borrower (i.e., issuer). The issuer agrees to pay the investor a stated rate of interest (called the coupon rate) on a regular basis over the term of the investment plus repay the principal on a specified date.

Because most debt investments trade in the marketplace where factors (e.g., interest rates, economic factors, and so on) determine their value, their price can fluctuate. For example, when interest rates decrease, the price of a security will generally increase: In contrast, when rates rise, prices typically fall.

Among the instruments in the Canadian fixed-income capital market are bonds and mortgage-backed securities.

(1). Bonds

This sector sub-divided, the category depending on the bond traded.

Categories include:

• Government of Canada Bonds

Also known as Canada Bonds, these have the highest credit rating available.

Actively traded in all major markets, these bonds constitute the primary sector of the Canadian fixed-income capital market. To access this market (for Government of Canada securities), an investor must submit bids through a dealer eligible to participate at auctions.

The federal government of Canada issues Canada Bonds. (In fact, in the Canadian bond market, the Government of Canada is the largest single issuer.) Secondary market activity for these bonds occurs over the counter between investment managers and dealers.

Generally, these bonds are a conservative type of bond investment. Similar to Treasury Bills, they are essentially risk-free if held to maturity. In fact, the Government of Canada fully guarantees the investment (i.e., principal and interest), regardless of the amount. As such, Canada bonds are regarded the safest Canadian investment available with a term of over one year.

 • Provincial and/or Municipal Bonds

According to the literature, provincial and municipal governments (and their agencies) constitute the secondary sector in the Canadian fixed-income capital market.

Bonds issued in this sector generally have longer terms of maturity.

Albeit not as safe as comparable Canada Bonds, provincial securities are extremely safe assets. However, provincial instruments are generally of lower credit quality and reduced liquidity.

Municipal bonds can vary in ratings depending on a myriad of factors (e.g., revenues the municipalities can raise to pay the interest on issues). Furthermore, provincial government(s) do not automatically guarantee municipal bonds.

Generally, new issues of provincial, municipal, (and/or private sector) securities are distributed through syndicates rather than auctions. Nonetheless, to access these, an investor must participate through a dealer.

Federal and provincial Crown Corporations also issue bonds. The Canadian Government guarantees those issued by federal crown corporations (e.g., Canada Mortgage and Housing Corporation, the Business Development Bank of Canada, and so forth). Bonds issued by provincial crown corporations are usually guaranteed by the corresponding government.

• Corporate Bonds

To raise capital (to finance operations and projects), a private business can borrow from banks, issue common and/or preferred stock, or issue debt.

These four types of corporate debt differ in their terms, covenants, and security. However, all are categorized as corporate bonds.

Corporate bonds are comparable in structure to government bonds.

However, while bonds in other sectors of the Canadian fixed-income capital market share characteristics, differing only in term of maturity and coupon, corporate issues are unique. In fact, research indicates that potential investors need to carefully analyze corporate bond variables.

Whereas payments on these bonds depend (to some degree) on the financial status of the issuer, a major consideration is default risk. In short, if the business goes bankrupt the bond holder may not receive all interest payments nor repayment at maturity.

(2). Mortgage-Backed Securities

Also called Pass-Throughs, mortgage-backed securities (MBSs) are fixed-rate investments representing ownership interest in a pool of mortgages. A mortgage is a contract pledging specified property as security for a loan and outlining repayment of the loan.

According to the literature, approved mortgage lenders (e.g., major banks, credit unions) originate and pool residential first mortgages. They then issue separate securities to investors, selling packages of these loans in the secondary market.

MBSs combine the investment features of real estate/residential mortgages and Canadian government bonds.

Investors receive monthly income consisting of a blend of principal and interest payments from a pool of mortgages.

There is essentially no risk with an MBS held to maturity. Under the Canadian National Housing Act (NHA), when held to maturity, the principal and interest are fully guaranteed regardless of size of investment. As such, these securities are regarded as one of the safest investments available in Canada.

A Final Point

This is one of many such markets on a worldwide basis. One commonality among capital markets is that in many fixed-income securities are an important segment.

Another, at least for participants who invest in these securities is the need to understand interest rates. When thinking about purchasing any security it is important to research past, present, and future expectations for rate trends

A major difference is that market conventions (for example, those commonly used in Canada’s markets) differ from those of other jurisdictions.

(References available upon request.)

NOTE: This preceding article has been for information purposes only