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C3: BUSINESS AND CORPORATE FINANCE

TOPIC: BOND VALUATION

AND ANALYSIS
Mr. Mshana: MFA-OG, B.com
Accounting Hons, CPA (T), ATEC (II)

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To be covered
ü Definition
ü Types of Bonds
ü Bond Valuation
• Under valuation
• Over valuation
ü Bond Yield
• Current Yield
• Yield to Maturity (YTM)
ü Duration
ü Convexity
ü Credit rating
ü Bond Refund Analysis
ü QNA Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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DEFINITION
A Bond
This refers to a financial instrument which is a debt
instrument that attracts interest payment over it’s life
and ultimately the repayment of principle at maturity.
OR

Is debt capital market instrument issued by a borrower,

who has to repay to the lender / investor the amount
borrowed along with interest, over a predetermined
period of time.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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DEFINITION
Examples of Bonds Currently Listed at DSE

MATURITY
NO BOND NO ISIN COUPON TENURE ISSUED DATE ISSUED AMOUNT (TZS)
DATE

1 NMB TZ1996104463 8.5 3 Year Bond 26/04/2022 28/03/2025 74,268,740,000

2 TMRC-18/23.T1 TZ1996103101 11.79 5 Year Bond 19/06/2018 18/06/2023 12,521,500,000

3 TMRC-19/24.T2 TZ1996103382 13.46 5 Year Bond 19/06/2019 20/06/2024 9,178,100,000

4 TMRC-21/26.T3 TZ1996103978 10.48 5 Year Bond 01/06/2021 18/05/2026 8,879,000,000

5 NBC-TWIGA 10 5 Year Bond 2022 2027

Sh38.9 billion

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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DEFINITION

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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DEFINITION
NBC BOND ISSUING ARTICLE

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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TYPES OF BOND
There are two main types of Bonds and these are coupon payment
Bond and Zero coupon Bond.
Coupon payment bond
This a regular kind of a bond that attracts interest in form of cash
payment during the life of it. Also called Plain Vanilla, straight Bond
or Bullet bond.
Zero coupon bond
A zero coupon bond is one which offers the entire payment at
maturity. In other words, there are no periodic interest payments.
Usually, the bonds are issued at a discount to the face value and at
maturity; the face value is paid in the absence of which an investor
would have no incentive to invest in these bonds. Zero coupon
bonds are also called deep discount bonds

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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BOND VALUATION
1. Coupon Payment Bond
The value of a Coupon payment bond is a present value of the
future cash flows expected to be derived from the bond, which are
the annual coupons and the maturity value of the bond. This value
is sometimes referred to as ‘Intrinsic Value’
PV of a Bond= PV of coupon payment + PV of principle (at
maturity)
* − * + -./ 0& 1"
!" #$ %#&' = ) +
-./ * + -./ &
YTM= Yield to Maturity
MV= Maturity value it would be the same as face value if the bond
is issued at par
C= Coupon payment (is the interest rate payments in terms of
monetary amounts Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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BOND VALUATION
Example 1 : A coupon Payment bond
Consider a bond with a coupon rate of 10% and annual
coupons. The par value is TAS 1,000 and the bond has 5
years to maturity. The yield to maturity is 11%.
Required: Compute the value of this bond
Example 2
A 10% Tshs 1.0 billion bond dated January 1, 2014 pays
interest semi-annually on June 30 and December 31 0f
each year. It has a maturity 0f 5 years and the market
interest rate is 12 percent. What is the price you will pay
for this bond?
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

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BOND VALUATION
2. Zero coupon
The value of a zero coupon Bond is a present value of the
future cash flows expected to be derived from the bond
which is a maturity value. This value is sometimes
referred to as ‘Intrinsic Value’
Use the same approach of discounting a single payment
except that under this case we discount the maturity
value of a zero coupon bond semi- annually. The
assumption is the interest rate compounds semi-annually.
)"
!" #$ %#&' =
,-. & 0 /
*+ /
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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BOND VALUATION
Example 3 : A zero coupon Bond
GMKES Plc. issues a bond with face value of TAS 10,000
over a period of 5 years.
Required: Compute the value of this bond assuming that
it is a zero coupon Bond and the maturity value is 10,000
with 12% Yield to maturity.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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OVER/UNDER VALUATION OF BONDS

The Intrinsic value as per the above formulas is now
compared to the market price of the bonds.
If the market price of bond is less than the Intrinsic
value, the bond is said to be under-valued.
If the market price of bond is higher than Intrinsic value
then the bond is said to be over-valued
If the market price of the bond is equal to Intrinsic value
the bond is said to be fairly-valued
Investors tends to buy undervalued bonds and sell
overvalued bonds in order to take advantage of the gap
between intrinsic and market value

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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OVER/UNDER VALUATION OF BONDS

For a Bond to be undervalued or Overvalued means that
the market price is somehow “wrong” and that the
investor either has information not available to the rest
of the market or is making a purely subjective, contrarian
evaluation.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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BOND YIELDS
Yield is an important concept in bond investing, as we use it
as a tool to measure the return of one bond as compared to
another. It enables the investor to make informed decisions
about which bond to buy.
1. Current Yield
Current yield is an investment's annual income (interest or
dividends) divided by the current price of the security. This
measure examines the current price of a bond, rather than
looking at its face value. Current yield represents the return
an investor would expect to earn, if the owner purchased the
bond and held it for a year. However, current yield is not
the actual return an investor receives if he holds a bond until
"#$%#& '(#$&)
maturity. Current Yield =
*+

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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BOND YIELDS
2. Yield to Maturity
Yield to maturity is the effective interest rate of the particular
bond over the life of it. It is the return that an investor gains by
receiving the present value of coupons payment, the par value
and the capital gains in relation to the price that is paid.
YTM is the interest (discount) rate at which the present values
of all the future cash flows equals the bond’s price (the concept
is identical to IRR). This is sometimes regarded as market rate
of interest.
There are two approaches to computing yield to maturity
which are as follows:
i. Using trial and error or interpolation method (same as
IRR)
ii. Using an approximation formula as follows:
Mr. Mshana: MFA-OG,%&'()
Bcom Accounting
"#(
Hons, CPA (T), ATEC )
* (II)
YTM = %&,()
( )
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BOND YIELDS
Example 4
Mr Scot has purchased bonds of MQD Ltd from the open market
at Tshs 1280 per bond. The par value of the bond is Tshs. 1200
@ 12% interest payable annually. The year to maturity is 10
years.
Required: Compute the YTM (Yield to Maturity) and current
yield
Example 5
Ruex Ltd issued bonds with maturity of 5 years @12% coupon
payable semi-annually on 1st January 2015. The bonds with
par value of Tshs 1000 are currently trading at Tshs 920.
Interest is paid through direct credit to investor account on 31st
March and 30th September.
Required: Calculate the YTM of the bond and current yield.
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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BOND YIELDS
The relationship between YTM and Coupon Rate
If the YTM is equal to the Coupon rate, the Bond is
trading at par
If the YTM is lower than the Coupon rate, the Bond is
trading above par (at Premium)
If the YTM is higher than the Coupon rate, the Bond is
trading below par (at Discount)

On the other hand the relationship between YTM and

bond prices is inverse such that as YTM increases,
bond prices decreases

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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DURATION
This concept relates to the concept of payback period
(discounted payback period), such that it measures the time that
the bond will take to repay it’s cost of purchase.
There are two types of duration under bond analysis which are:
a) Macaulay Duration
b) Modified Duration

MACAULAY DURATION
This measures the number of years required to recover the true
cost considering the present value of all coupon and principle
payments received in the future. I.e. the effective (weighted) time
period to recover investment in bond.
∑ #$ % &
Macaulay Duration =
∑ #$
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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DURATION
MODIFIED DURATION
This is an extension to Macaulay Duration which measures the
sensitivity of bond prices due changes in interest rate.
In essence it measures by how much a bond price would change
due to changes in interest rate.
This can be computed as follows:
Maculay Duration
Modified Duration =
(#$%&')
In order to get a change in bond price due to a certain change in
YTM use the below:
%change in p = ')*+,+-* ./012+)3 4 %67138- +3 %&'
change in p = ')*+,+-* ./012+)3 4 %67138- +3 %&' x :;
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

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DURATION
Example 06
Diamond Ltd has issued an 8% coupon rate bond with a face value
of Tshs 1000, and redeemable after four years. Considering the
market interest rate at 10%.
Required: what would be the duration of the bond.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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USEFULNESS OF BOND DURATION

• Bond Duration helps investors to quantify the impact
of interest rate risk (interest rate fluctuations) i.e. It
predicts how sharply the market price of a bond will
change as a result of changes in interest rates.
• On the other hand Bond duration helps investors to
immunize themselves against credit risk (default).
• Duration allows bonds of different maturities and
coupon rates to be comparable, making evaluation
easier. Interest rate risk of a portfolio can be
managed by making changes in the duration of the
portfolio of bonds.
Note: the higher the duration the more sensitive the
bond price is to theMr.changes
Mshana: MFA-OG,in
Bcominterest
Accounting rates.
Hons, CPA (T), ATEC (II)

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LIMITATION OF DURATION
• One limitation is that duration is only an approximation of
the price sensitivity of a debt instruments, and is only
accurate as a measure of risk for relatively small changes
in relation to the current market price or yield, i.e. it
assumes a linear relationship between changes in
interest rates and prices. This can be resolved by using
convexity.
• Another drawback is that duration does not consider
changes in the price of the debt instrument due to a
change in the credit rating or default by the company.
• Additionally, duration also does not consider the fact that
callable bonds/ debentures can be redeemed before
their maturity by the issuer of the bond/ debentures.
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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DURATION GAP
Duration gap is a measure of the difference between entity’s
interest sensitive assets and interest sensitive liabilities. It basically
measures the sensitivity of liabilities and assets due to changes in
market interest rate.
Positive Duration Gap
Here the entity’s interest sensitive assets exceeds interest sensitive
liabilities i.e. Assets Duration is more than Liabilities Duration. In
this case if market interest rate increases, the value of Assets will fall
more sharply than the value of liabilities and consequently reducing
entity’s equity.
Negative Duration Gap
Here the entity’s interest sensitive liabilities exceeds interest
sensitive assets i.e. Liabilities Duration is more than Assets Duration.
In this case if market interest rate increases, the value of Liabilities
will fall more sharply Mr.than
Mshana:the
MFA-OG,value of assets and consequently
Bcom Accounting
increasing entity’s equity. Hons, CPA (T), ATEC (II)

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DURATION GAP
Zero Duration gap
Under this circumstance the entity’s interest sensitive
assets equals interest sensitive liabilities i.e. Assets
Duration is equal to Liabilities Duration. In this case if
market interest rate increases, the value of Assets will
fall in the same proportion as the value of liabilities and
consequently having no impact on entity’s equity.
If the company wishes to immunize itself against interest
rate risk (fluctuation of interest rate) then it should
maintain a zero duration gap while observing an optimal
weight of interest sensitive assets and interest sensitive
liabilities
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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CONVEXITY
Unfortunately, duration has limitations when used as a
measure of interest rate sensitivity. The statistic
calculates a linear relationship between price and yield
changes in bonds. In reality, the relationship between
the changes in price and yield is convex.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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CONVEXITY
Convexity, which is a measure of the curvature of the
changes in the price of a bond in relation to changes
in interest rates, is used to address this error.
Basically, it measures the change in duration as
interest rates change.
In general, the higher the coupon, the lower the
convexity - a 5% bond is more sensitive to interest
rate changes than a 10% bond.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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CREDIT RATING
An investment in a company’s equity or debt is accompanied
by a risk. Credit risk is the risk that a borrower will not
repay the loan and default on the borrowing. A company
desiring to issue bonds will need a credit rating.
Many credit rating agencies such as Moody’s, Standard &
Poor’s and Fitch, perform financial research and analysis on
commercial and government entities.
A bond's rating helps a lender to assess that bond's credit
quality compared to other bonds. These agencies rank the
creditworthiness of borrowers using a standardised ratings
scale. These agencies address the possibility that a financial
obligation will not be honoured as promised. Such ratings
reflect both the likelihood of default and the probability of a
financial loss suffered in the event of default.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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CREDIT RATINGS AND BOND YIELD

Credit ratings affect a bond's yield and the return

that investors expect on the bond.
A highly rated bond usually has a lower yield. This is
because the bond issuer does not have to offer a high
coupon rate in order to attract investors.
A lower rated bond usually has a higher yield. This is
because the investors require an incentive to
compensate for the higher risk associated with the
bond.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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BOND REFUND
This is when an entity wants to refund/redeem a bond prior
to it’s maturity date. This would be undertaken with the idea
of replacing the same with a debt carrying lower interest rate.
Factors Influencing Bond refund analysis
i. The interest rate scenario – whether rates are expected to
fall further or even out. Further decisions on switching
from fixed rate loans to floating rate loans or vice versa is
also critical.
ii. The estimated savings in interest outflow from
replacement of debt (post tax)
iii. Flotation costs that would be incurred on new issue
iv. Tax saving impacts on interest outflow, floatation costs
etc.
v. Period between incurring new debt and replacement of
old debt Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

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QUESTIONS AND ANSWERS

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
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Question 1
A five year bond of Makumbusho Company has a 10% coupon payable annually.
The bond face value is TZS. 1,000,000 and its Yield to Maturity (YTM) is
estimated at 10%. The management of Makumbusho Co. expects market interest
rates to increase from the current 10% to 12% thus pulling down the value of
the bond. You are a financial analyst and have been approached by the Board of
Directors of Makumbusho Company to explain the theoretical implication of
changes in market rates on bond prices. The board has also once heard of the
concept of Duration. They would also like to learn its relation to maturity.
Required:
i. Calculate and comment on the current price of Makumbusho Company’s
bond
ii. Prepare a brief report for Makumbusho company’s Board which describes
the usefulness of duration and calculate Duration of the bond
iii. Change in bond price both in percentage and in TZS should the market
interest rate increase from 10% to 12% as per management forecast
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

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Question 02
You have working with MAISARA Co. as a financial and investment analyst.
MAISARA Co is considering an investment in Benson Co.’s bonds. The company
plans to hold the bonds for only one year before selling them in the secondary
market. Benson Co’ bonds are redeemable at a 2 percent premium in five years.
Additional details of Benson’s bonds are as given below:
Bond Par Value TZS 10,000,000
Coupon Rate (payment on annual basis) 10%
Yield to Maturity 10%
Modified duration at the Current Yield to Maturity 3.79 Years
MAISARA Co considers duration of the bond to be a key factor when making
investment decisions. The company investment in bonds is primarily motivated
by realization of capital gains.
Required:
1. Estimate the Macaulay duration and the market price of MAISARA Co.’s bond
2. Estimate the new bond price and the capital gain or loss upon selling the
bond one year later if the interest rate decreases from 10% to 8% using the
Duration Rule.
3. Comment on the relationship between ‘bond price’ and ‘market interest rate
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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QUESTION 03
ABE has surplus cash which can be invested for at least five years. The company
has consulted you to help them choose an investment that gives the shortest
recovery period. The company presented the information on two types of bonds
as follows;
Bond Redemption Nominal Redemption Coupon Price TAS
Value TAS value Rate

A redeemable in 1,000 At par 7.00 950

5 years

B redeemable in 1,000 At 5% 7.50 1,010

6 years premium

Required:
Use Macaulay Duration method to advise ABE on the best Bond option to
select for their investment.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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QUESTION 04
Algorithmic Ltd has issued a bond which is redeemable after five
years at a coupon rate of 9% and a face value of TAS 100 million.
(a) Given that the Gross Redemption Yield (GRY) is at 10%,
determine the following:
(i) Macaulay Duration of the bond,
(ii) Modified Duration.

(b) Explain two (2) benefits and limitations of duration to

investors.
(c) Discuss the impact on duration of:
(i) Longer dated bonds,
(ii) Lower coupon bonds, and
Mr. Mshana: MFA-OG, Bcom Accounting
(iii) Lower yields. Hons, CPA (T), ATEC (II)
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QUESTION 05
DAMON Co is considering an investment in one of two corporate bonds. Both
bonds have a par value of TZS. 1,000 and pay coupon interest on an annual basis.
The market price of the first bond is TZS. 1,079.68. It’s coupon rate is 6% and it
is due to be redeemed at par in five years. The second bond is about to be issued
with a coupon rate of 4% and will also be redeemable at par in five years. Both
bonds are expected to have the same gross redemption yields (yields to
maturity). DAMON Co considers duration of the bond to be a key factor when
making decisions on which bond to invest.
Required:
i. Estimate the Macaulay duration of the two bonds DAMON Co is considering
for investment.
ii. Calculate the effect on the price of each of the two (2) bonds of a general
rise in interest rates by 50 basis points.
iii. Discuss how useful duration is as a measure of the sensitivity of a bond’s
price to changes in interest rates

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

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QUESTION 06
National Social Security Fund bought building materials on loan from a United
Kingdom Company for its Ubungo apartments and will be paying GBP 1000 for
each of the next five years. The managing Director Dr Mzee asked the Director of
Investment Mr Bajaji to create a bond portfolio so as to reduce cash outflow
impact.
Mr Bajaji created a bond portfolio on only two available Euro – sterling bonds, a
one year bond with a 6% coupon and a four year bond with 8% coupon. The
Euro – sterling interest rate is currently 10%
Required:
i. Determine the correct amount of each bond Mr Bajaji should buy to
immunize the portfolio from interest rate risk
ii. Show how the value of the assets and liabilities would change if the
discount rate falls to 9.5% or Rises to 10.5% and in each case explain what
you observe from your computation
iii. Comment on the underlying assumptions for the above immunization
strategy to work Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
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QUESTION 07
Boni Holdings Plc (Boni Ltd) has in issue bonds with nominal values of TZS 100
and a coupon rate of 8%, which are redeemable at a 5% premium in five (5)
years’ time. The current market value of each bond is TZS 85. Alternatively, each
bond may be converted on that date into 20 ordinary shares of the company that
currently has market price of TZS 4. The current ordinary share price of Boni is
expected to grow at a rate of 7% annually for the foreseeable future. The
company has a corporate tax rate of 30% per annum. Required: Calculate the
following values for each TZS 100 convertible bond:
i. Conversion value;
ii. Cost of the convertible bond to Boni Holdings Plc ;
iii. Conversion premium and explain its significance.

Food Ltd has in issue 12% bonds with par value TZS 150,000 and redemption
value TZS 165,000 with interest payable quarterly. The cost of debt on the bonds
are 8% annually and 2% quarterly. The bonds are redeemable on 30 June 2021
and it is now 31 December 2017.
Mr. Mshana: MFA-OG, Bcom Accounting
Required: Calculate the market value of(T),
Hons, CPA the bonds.
ATEC (II)

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THE END

BE EVER BLESSED BEYOND MEASURES!!

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)