WealthHow Bond Yields Work in Canada
What Is a Bond, Exactly?
When the Government of Canada or a corporation needs to raise money, it can borrow from investors by issuing bonds. When you buy a bond, you're lending money for a set period — say 5 or 10 years — and in return:
- you receive regular interest payments (the coupon);
- you get your principal back at the maturity date.
Example: a $1,000 Government of Canada bond with a 4% coupon pays you $40 per year until maturity, then returns $1,000. Straightforward on paper — but the bond's market value fluctuates constantly in the meantime.
Coupon Rate, Current Yield, and Yield to Maturity
Three terms worth knowing:
- Coupon rate: the interest rate locked in when the bond was issued (e.g., 4%). It never changes.
- Current yield: the coupon divided by the bond's current market price. If you buy a $1,000 bond for $950, your current yield rises to about 4.2%.
- Yield to maturity (YTM): the total annualized return if you hold the bond until full repayment, accounting for coupons and the capital gain or loss relative to what you paid. This is the most complete measure for comparing bonds.
The Golden Rule: Price and Yield Move in Opposite Directions
This is the central concept. Imagine you hold a bond paying a 3% coupon, issued when rates were low. The Bank of Canada then raises its policy rate, and new bonds are issued at 5%. Who would pay $1,000 for your 3% bond when they can buy a new one at 5%? Nobody — unless you sell it for less.
That's exactly what happened in 2022: the Bank of Canada raised its policy rate from 0.25% to 4.25% in a matter of months. Existing bonds fell sharply in value.
| Interest Rate Movement | Effect on Bond Price | Effect on Yield |
|---|---|---|
| Rates rise ↑ | Price falls ↓ | Yield rises ↑ |
| Rates fall ↓ | Price rises ↑ | Yield falls ↓ |
| Bond type | Rate move | Approx. price impact |
|---|---|---|
| 2-year bond | Rates rise by 1% | Loses about 2% |
| 7-year duration bond | Rates rise by 1% | Falls by roughly 7% |
| 20-year bond | Rates rise by 1% | Could lose 15% or more |
Duration: Why Long-Term Bonds Are More Sensitive
Duration measures how sensitive a bond's price is to interest rate changes. The further away the maturity date, the higher the duration — and the more the price swings.
- A 2-year bond might lose about 2% if rates rise by 1%.
- A 20-year bond could lose 15% or more for the same rate increase.
That's why long-term bond ETFs — such as those tracking 30-year Government of Canada bonds — are far more volatile than short-term bond ETFs. It's not that they're fundamentally riskier; they just react much more strongly to rate changes.
Lean Government of Canada bonds
- Considered virtually free of default risk
- The federal government can always raise taxes or issue currency
- Serve as the risk-free benchmark for the entire financial system
Lean corporate bonds
- Typically offer a higher coupon to compensate for credit risk
- The lower the credit rating (high-yield/"junk" bonds), the higher the coupon and the higher the risk
- Risk depends on whether the company might not repay
Government vs. Corporate Bonds: Credit Risk
Not all bonds are created equal. Government of Canada bonds are considered virtually free of default risk — the federal government can always raise taxes or issue currency. According to the Bank of Canada, these bonds also serve as the risk-free benchmark for the entire financial system.
Corporate bonds typically offer a higher coupon to compensate for the risk that the company might not repay (credit risk). The lower the credit rating — think high-yield or "junk" bonds — the higher the coupon and the higher the risk.
GICs (Guaranteed Investment Certificates) work similarly to bonds: you lend money to a financial institution for a fixed term at a fixed rate. They're insured by CDIC up to $100,000, but they're illiquid — you generally can't sell them before maturity. See our GIC vs. stock market comparison for more.
Why Hold Bonds in Your Portfolio?
Bonds traditionally serve three roles:
- Stable income: coupons provide a predictable cash flow, valuable in retirement.
- Stability: government bonds tend to hold their value better than stocks during market crises.
- Diversification: bonds have historically had a low correlation with equities, cushioning portfolio drawdowns. Learn more about the role of bonds in a Canadian portfolio.
To access bonds without buying individual securities, Canadian bond ETFs offer a diversified, low-cost option. Keep in mind: while individual bonds are repaid at face value at maturity, a bond ETF has no fixed maturity date — its price will fluctuate with market rates.
To understand how monetary policy affects all your investments, see our article on how interest rates affect investments in Canada. For additional resources on bonds, GetSmarterAboutMoney (OSC) offers solid, unbiased guides.
🏦 Calculator: a bond's current yield
Current yield = annual coupon ÷ price paid.
Current yield ignores gain/loss at maturity (≠ yield to maturity). For information only.
Frequently asked questions
Why do bond prices fall when interest rates rise?
Because newly issued bonds offer a higher coupon. For your existing bond to remain competitive, its price must drop until its effective yield matches the new bonds on the market. It's straightforward supply and demand in the secondary market.
What is yield to maturity (YTM)?
YTM is the total annualized return you earn if you buy a bond at today's price and hold it until full repayment. It factors in the coupon payments, the price you paid, and the face value returned at maturity — making it the most complete measure for comparing bonds.
Are Government of Canada bonds risk-free?
They're virtually free of default risk — the federal government has always repaid its debts. But they carry interest rate risk: if you need to sell before maturity when rates are higher, you could take a loss on the market price.
What is bond duration?
Duration measures how much a bond's price changes for a 1% move in interest rates. A duration of 7 years means a 1% rate increase will cause the bond's price to fall by roughly 7%. The longer the duration, the more sensitive the bond is to rate changes.
Why does my bond ETF lose value if bonds are supposed to be safe?
A bond ETF holds dozens or hundreds of bonds whose prices fluctuate daily with interest rates. Its net asset value reflects those real-time prices. By contrast, if you held an individual bond to maturity, you'd receive your full principal back regardless of interim price swings — the volatility along the way wouldn't affect your final payout.
Are GICs the same as bonds?
They share the same basic logic: you lend money at a fixed rate for a fixed term. The key difference is liquidity: a bond can be sold on the market before maturity (at a gain or a loss), while a GIC is generally locked in until term. GICs are also CDIC-insured up to $100,000, which bonds are not.
Sources & references
Educational content; verify figures with official sources before acting.