INVESTMENT BONDS

What is a Bond?
A bond is a loan that an investor makes to a corporation, government, federal agency or other
organization. Bonds are sometimes referred to as debt securities. Since bond issuers know an
investor is not going to lend money without compensation, the issuer of the bond (the borrower)
enters into a legal agreement to pay the investor (the bondholder) interest. The bond issuer
also agrees to repay investors the original sum loaned at the bond's maturity date. The majority
of bonds have a set maturity date—a specific date when the bond must be paid back at its face
value, called par value. Bonds are called fixed-income securities because many pay interest
based on a regular, predetermined interest rate—also called a coupon rate—that is set when
the bond is issued.
A bond's term, or years to maturity, is usually set when it is issued. Bond maturities can range
from one day to 100 years, but the majority of bond maturities range from one to 30 years.
Bonds are often referred to as being short-, medium- or long-term. Generally, a bond that
matures in one to three years is referred to as a short-term bond. Medium- or intermediate-term
bonds are generally those that mature in four to 10 years, and long-term bonds are those with
maturities greater than 10 years.

Types of Bonds

There are four primary categories of bonds sold in the markets. However, you may also see
foreign bonds issued by corporations and governments on some platforms.

 Corporate bonds are issued by companies. Companies issue corporate bonds to raise
money for capital expenditures, operations and acquisitions.

Companies issue bonds rather than seek bank loans for debt financing in many cases
because bond markets offer more favourable terms and lower interest rates. Corporate
bonds can be classified according to their maturity. Maturities can be short term (less
than three years), medium term (four to 10 years) or long term (more than 10 years).
Longer-term bonds usually offer higher interest rates but may entail additional risks.
Many corporate bonds pay a fixed rate of interest throughout their term but some
bonds may offer floating or variable rates that are reset periodically. Floating or
variable rate bonds adjust their interest payments to changes in benchmark rates or
market interest rates.

 Government bonds such as those issued by the Central Government through the
Treasury. Bonds issued by the Treasury with a year or less to maturity are called
“Treasury Bills”; bonds issued with 1–10 years to maturity are called “notes”; and

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 bonds issued with more than 10 years to maturity are called “bonds”. The entire
category of bonds issued by a government treasury is often collectively referred to as
"treasuries." Government bonds issued by national governments may be referred to as
sovereign debt.

Common Terms for Bonds

Most bonds share some common basic characteristics including:

 Face value is the money amount the bond will be worth at maturity; it is also the
reference amount the bond issuer uses when calculating interest payments. The par
value is not the same as the price paid for a bond. Bonds may be sold or trade at prices
that are at a discount from (i.e., lower than) the par value or at a premium from (i.e.,
higher than) the par value. For example, say an investor purchases a bond at a premium
K1,090 and another investor buys the same bond later when it is trading at a discount
for K980. When the bond matures, both investors will receive the K1,000 face value of
the bond.
 The coupon rate is the rate of interest the bond issuer will pay on the face value of the
bond, expressed as a percentage. The coupon or coupon rate of a bond is the annual rate
of interest paid to investors on the bond. The coupon rate is paid on the bond’s par value
and is set when the bond is issued. For example, a 5% coupon rate means that
bondholders will receive 5% × K1000 face value = K50 every year. Interest is typically
paid out semi-annually unless otherwise stated. Bonds may have fixed interest or
coupon rates or may have floating or variable rates that are reset or adjusted from time
to time. Variable rates may be linked to a benchmark, such as short-term Treasury bills,
various published rates, or to a bond index. Zero-coupon bonds do not pay interest;
rather, they are sold a significant discount to their par value and at maturity the par
value is paid.
 Coupon dates are the dates on which the bond issuer will make interest payments.
Payments can be made in any interval, but the standard is semi-annual payments.
 The maturity date is the date on which the bond will mature and the bond issuer will
pay the bondholder the face value of the bond.

Example:
A bond with a K1,000 face value and a six per cent coupon will pay its bondholders
K30 every six months (or K60 per year) until the bond’s maturity date. When the bond
matures, the investor is repaid the full K1,000 face value.

 The issue price is the price at which the bond issuer originally sells the bonds.
 Bond Price is the market price at which the bond trades. This price may be different
from the par value. A bond’s price may be affected by numerous factors, including
prevailing interest rates and the issuer’s creditworthiness. Generally, as prevailing
interest rates go up, a bond’s price will go down because the coupon is less attractive

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 to potential investors, and as interest rates go down, bond’s price will go up because
the coupon is more attractive to potential investors. Bonds are generally sold in
denominations of K1,000 and prices are expressed as a percentage of par. Thus, a bond
price of 101.25 would mean that the bond would have a market value of 101.25% of
par, or K1,012.50 (assuming K1,000 par value).

Yield
Yield is the return you get on a bond.
 The current yield is the annual return on the Kwacha amount paid for the bond. It is
calculated by dividing the Kwacha amount of the coupon rate by the purchase price.
Example
 A bond with a K1,000 face value and a 6.5 per cent coupon, purchased at
par, has a current yield of 6.5 per cent (annual interest of K65 divided by
K1,000 purchase price).
 The same bond purchased at K950 (i.e., purchased at a discount) would
have a current yield of 6.84 per cent (K65 interest divided by K950 purchase
price).
 And, if the price rises to K1,100, the current yield drops to 5.90 per cent
(K65 divided by K1,100).
 Yield to maturity is the overall interest rate earned by an investor who buys a bond at
the market price and holds it to maturity. Mathematically, it is the discount rate at which
the sum of all future cash flows (from interest and principal payments, assuming they
are all paid on time and that the interest is reinvested at the same rate) equals the price
of the bond. Yield to maturity will be the same as the current yield if the bonds were
purchased at par value, will exceed the current yield if the bonds were purchased at a
discount to the par value, and will be less than the current yield if the bonds were
purchased at a premium.

 Maturity
The maturity of a bond is the future stated date when the principal will be repaid and
interest payments will end. A bond’s maturity is different from its duration.
 Duration
Duration is a measure of the sensitivity of the price of a bond to changes in prevailing
interest rates. Duration is often quoted in years but the number reflects the percentage
change in a bond’s price for each 1% change in interest rates. Duration is primarily
affected by the bonds’ coupon rate, yield, and remaining time to maturity.

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 Examples
1. Mr Kazuba buys a 12 year government bond whose par value is K50 000.00 and has a
coupon rate of 6.5%. Calculate
(a) The amount of interest Mr Kazuba earns over the life of the bond.
(b) The amount Mr Kazuba receives on the bond’s maturity date.
(c) The total amount Mr Kazuba receives for buying a K50 000.00 government bond over
its duration.

Solution

(a) Investment/par value = K50 000.00 coupon rate = 6.5 % Duration = 12 years

Interest = Coupon rate × Investment × Period

6.5
= × K 50 000.00 ×12
100

6.5×50000.00×12
=
100

= K39 000.00

(b) At the maturity date, the final years’ interest plus the par value is paid
Amount received on the maturity date = Investment + Interest for 1 year
Investment = K50 000.00 Interest = ?
Interest = Coupon rate × Investment × Period

6.5
= × K 50 000.00 ×1
100

6.5×50000.00×1
=
100

= K3 900.00

Amount received on the maturity date = K50 000.00 + K 3 900.00

= K53 900.00
(c) Total Amount received = Investment + Interest over 12 years
Investment = K50 000.00 Interest over 12 years = K39 000.00
Total Amount received = K50 000.00 + K39 000.00
Total Amount received = K89 000.00

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2. Given that the total amount of interest accrued over the life of the bond is K8 000.00, if the
coupon rate is 10% and face value of K20 000.00. Calculate the duration of a bond?
Solution

Investment/par value = K20 000.00 coupon rate = 10 % Duration = ?

Interest = Coupon rate × Investment × Duration

10
K20 000.00 = × K 50 000.00 × Duration
100

K20 000.00 = K 5 000.00 × Duration

Duration = 4 years

3. Given that the total amount of money at the end of a bond period is K44 400.00 if the par
value of a bond is K30 000.00 at the coupon rate of 6%. Calculate the duration of the bond?
Solution
Total amount = Par value + Interest over bond duration
Interest = K44 400.00 – K30 000.00
= K14 400.00

Interest = Coupon rate × Investment × Duration

6
K14 400.00 = × K 30 000.00 × Duration
100

K14 400.00 = K 1 800.00 × Duration

Duration = 8 years

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SHARES AND DIVIDENDS
Shares
These are units of ownership interest in a company’s asset that provide for an equal
distribution in profits, if any are declared. They are also called stocks.
Someone who owns one or more shares is called a shareholder.
Shareholders may receive cash flows (dividends) if a company’s board of directors declare
that the company has performed well and has enough profit to distribute to its shareholders.
A share in the company gives you the right to vote on decisions affecting the company.
You can also call a share, ‘equity’ or ‘stock’.

There are two types of shares namely: Preference and Ordinary shares.
Preference shares
Preference shares are instruments that have debt (fixed dividends) and equity (capital
appreciation) characteristics;
Preference shareholders are paid fixed-rate dividends before dividends are paid to ordinary
shareholders.
Preference shareholders have a higher claim on assets (repayment of capital if company is
wound up) and earnings (dividends) than ordinary shareholders;
Cumulative:dividend is accumulated if the company does not earn sufficient profit to
pay the dividend i.e., if the dividend is not paid in one year it will be carried forward
to successive years;
Non-cumulative:if the company is unable to pay the dividend on preference shares
because of insufficient profits, the dividend is not accumulated. Preference shares are
cumulative unless expressly stated otherwise;
Participating: participating preference shares, in addition to their fixed dividend,
share in the profits of a company at a certain rate;
Convertible: apart from earning a fixed dividend, convertible preference shares can
be converted into ordinary shares on specified terms;
Redeemable: redeemable preference shares can be redeemed at the option of the
company either at a fixed rate on a specified date or over a certain period of time.

Ordinary share
An ordinary share is the most common class of share representing the shareholder’s
proportional interest/ownership in a company.
These shares do not have preferential rights, as is the case with preference shares. Ordinary
shareholders may receive dividends if any are available and after dividends on preferred
shares are paid to the preference shareholders.

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The share price is the price at which a particular share can be bought or sold. The share price
is determined by the supply and demand for a particular company’s shares.

Factors affecting the share price

 When you have more buyers than sellers for a particular company’s shares, share
prices usually rise because these shares are in demand.
 When you have more sellers than buyers for a particular company’s shares, share
prices usually fall because there are more of these shares available.
 If a company is very profitable, a share in that company will become more valuable
because more people think that it is a good investment.
 Factors such as economic and political events also influence share prices.

Some terms related with a share

1. The original value of a share is called its nominal value or face value or printed value.
The nominal value of a share always remains same. This value is printed on the certificate.
2. The price of a share at any time is called its market value or cash value. The market value
of a share changes from time to time depending market forces.
3. If the market value of a share is the same as its nominal value, the share is called at par
and the share is said to have a par value.
4. If the market value of a share is more than its nominal value, the share is called at
premium or above par. If a share of K 20.00 is selling at K22.50, then it is said to be
selling at a premium of K2.55 or at K2.50 above par.
5. If the market value of a share is less than its nominal value, the share is called at
discount or below par. If a share of K20.00 is selling at K18.50, then it is said to be
selling at a discount of K1.50 or at K1.50 below par.

Dividends
The profit, which a shareholder gets for his/her investment from the company, is called
dividend.
1. The dividend is always expressed as the percentage of the face value of the share.
2. The dividend is always given (by the company) on the face value of the share
irrespective of the market value of the share. This takes into account the type of the
shares investors hold.
The dividend is usually quoted in Kwacha amounts in terms each share i.e. Dividends Per
Share (DPS) e.g. K 0.20 dividend per share. It can also be quoted in terms of a percent of the
current market share price, referred to as the Dividend Yield (DY). This is done only done
preference shares.
Dividends may be in the form of cash or shares.

A company with a profit at the end of its financial year, can make one or a combination of the
following choices to distribute these funds:
 Reinvest in the business to fund future growth and expansion plans
 Buy its own shares through share repurchases and buyback agreements
 Make a dividend pay out which puts cash back in the hands of its shareholders

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Dividends can be paid out on a quarterly, semi-annual or annual basis, depending on the
company’s policy. These dividends to ordinary shareholders are however never guaranteed.

Formulae
1. Investment
Money invested = number of shares × market value of one share.
Example
A Woman bought 700 shares whose nominal value each is K80.00 at K60. Calculate
the amount of money she spent.
Solution
Market value = K60.00 Number of shares = 700
Money Invested = 700 × K60.00
= K42000.00

2. Income and Return

(a) Annual income = number of shares × rate of dividend × face value of one share
annual income
(b) Rate of return = ( × 100) %
investment

3. Number of shares
investment annual income
Number of shares purchased (or held) = market value of one or income on one share

Example
A man bought 500 shares, each of face value K10, of a certain business concern and
during the first year after purchase received K400 as dividend on his shares. Find the
rate of dividend on shares.
Solution
Let the rate of dividend be r % per annum.
Annual dividend = number of shares × rate of dividend × face value of one share
= 500 × 100 r × K10 = K50 r
Given, dividend received after one year of purchase of shares is K400.
∴ K50 r = K400 ⇒ 50 r = 400 ⇒ r = 8.
Hence, the rate of dividend = 8%.

Example
A man invests K9600 on K100 shares at K80. If the company pays him 18% dividend,
find :
(a) the number of shares he buys.
(b) his total dividend.
(c) his percentage return on the shares.

Solution.
(a) Investment = K9600, market value of one share = K80.

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 investment K9600
∴ The number of shares bought = market value of one share = = 120 shares
K80
(b) Total dividend = number of shares × rate of dividend × face value of one share
18
= 120 × × K100
100
= K2160.
(c) K2160 is the income on K9600,
2160 45
∴ rate of return on shares = ( 9600 × 100) % = % = 22·5%.
2

Further Examples
Example
A man wants to buy 62 shares available at K132 (par value of K100).
(a) How much should he invest ?
(b) If the dividend is 7·5%, what will be his annual income ?
(c) If he wants to increase his annual income by K150, how many extra shares should he buy?

Solution
(a) Since the market value of one share (par value K100) is K132,
∴ market value of 62 shares = K(132 × 62) = K8184.
∴ The man should invest K8184.
(b) Annual income = number of shares × rate of dividend × face value of one share
.75
= 62 × × K100
100
= K(62 × 7·5) = K465.
(c) Since income on one share is K7·5,
K150
∴ for income of K150, the number of shares = = 20 shares.
K7.50
Thus, to increase the income by K150, the number of extra shares to be purchased = 20.

Example
The dividend due on 1 000 shares at the end of a financial year is K2 250.00. If the annual
dividend rate is 3% of the share value, calculate the value of each share.

Solution
annual income
Dividend rate = ( investment
× 100) %
K2 250.00
3% = (Investment × 100) %

K225 000.00
Investment = ( ) %
3%

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 Investment = K75 000.00

Money invested = number of shares × market value of one share.

K75 000.00 = 1000 × market value of one share
Market value of one share = K75.00

Alternatively
K2 250.00
Dividend per share =
1 000

= K2.25
K2.25
Dividend rate = (Value of a Share × 100) %
K2.25
3% = ( × 100) %
Value of a Share

K225.00
Value of a share = ( ) %
3%
Value of a share = K75.00

Example
A man invests K6 000.00 in K10.00 shares when their market price is K8.00 each.
(a) How many shares does he buy?
(b) If the dividend rate is 5.5%. What is his dividend?
(c) Given that the man sells his shares at K8.60. How much profit does he make on sales?

Solutions

(a) Investment = K6000.00, market value of one share = K8.00.

investment
∴ The number of shares bought = market value of one share
K6000.00
=
K8.00
= 750 shares
(b) Total dividend = number of shares × rate of dividend × face value of one share
5.5
= 750 × × K10.00
100
= K412.50.
(c) Profit on shares = selling price – cost price
= (750 × K8.60) - (750 × K8.00)
= 750 × K0.60
= K450.00

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Example

The initial capital of the company consists of 90 000, 8% preference shares of K80.00 each
and 156 000 ordinary shares of K60.00 each. The profits available are K1 200 000.00

(a) What dividend can be paid to ordinary shareholders?

(b) What is the dividend percentage of an ordinary share?

Solutions

(a) Dividends on preference shares are fixed.

8
Dividends of preference shares = × K80.00 × 90 000
100
= K576 000.00
Dividends of ordinary shares = Available Profits – Dividends of preference shares
= K1 200 000.00 – K576 000.00
= K 624 000.00

annual income
(b) Dividend percentage = ( × 100) %
investment

Investment of ordinary shares = K60.00 × 156 000

= K936 000.00

624 000
Dividend percentage = (9 360 000 × 100) %

= 6.67 %

Alternatively
Dividend per ordinary share = dividends ÷ number of shares
624 000
=
156 000
= K4.00
4
Dividend percentage = (60 × 100) %

= 6.67 %

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Example

A company makes a profit of K2 500 000.00. The company decides to invest 25% of the
profit into the company and pays the remaining amount as dividends. There are 150 000
shares of K 180 each.

(a) What amount of money is paid out in dividends to shareholders?

(b) Calculates the dividend percentage per share.

Solutions

(a) The company reinvests 25% of the profit:

25
25% of the profit = × K2 500 000.00
100
= K 625 000.00
Dividends = K2 500 000.00 – K650 000.00
= K1 875 000
annual income
(b) Dividend percentage = ( × 100) %
investment

Investment of shares = K180.00 × 150 000

= K27 000 000.00

1 875 000
Dividend percentage = (27 000 000 × 100) %

= 6.94 %
Alternatively
Dividend per ordinary share = dividends ÷ number of shares
1875 000
=
150 000
= K12.50
12.50
Dividend percentage = ( 180 × 100) %

= 6.94 %

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 Example

A man buys 800 shares whose nominal value is K70.00 at K40.00 each. If the dividend rate is
12% of the nominal value.

(a) How much does he get in dividend?

(b) What is the current yield on his investment?

Solutions

(a) Dividend = rate × nominal value × number of shares

= 0.12 × K70.00 × 800
= K6720.00
(b) Current Yield on Investment = (Dividend per share ÷ Market Share Price) × 100%
6720.00
Dividend per share =
800
= K8.40
Market Share Price = K40.00
8.40
Current Yield on Investment = × 100%
40
Current Yield on Investment = 21 %

Difference between preference shares and ordinary shares

Preference Shares Ordinary Shares

Shareholders have a preferential right in terms
of entitlement to receipt of dividends as well as
repayment of capital in the event of the
company being wound up.
They offer shareholders a fixed dividend each
year.
Shareholders have no voting rights and in the
event of non-payment of dividends may have a
cumulative dividend feature that requires all
dividends to be paid before any payment of
common share.
Shareholders are entitled to dividends as well as
residual economic value should the company
unwind (after bondholders and preference
shareholders are paid).
Ordinary shareholder dividends can be higher
than preference shareholder dividends as
dividends for ordinary shares are not fixed.
Ordinary shareholders have the right to vote at
Annual General Meetings and they have the
ability to elect the Board of Directors of a
company.

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