SESSION 1

BONDS & BOND VALUATION

Dr. Maryam Kriese
UGBS
 Learning Objectives

• Appreciate the key features of a bond

• Understand the key issuers of bonds in the bond market &

why

• Learn the importance of the yield curve

• Learn how to value a bond based on its coupon rate & YTM

• Examine the relationship between yield & price

• Appreciate Credit Ratings

 Introduction
 There are two major /fundamental sources of finance for businesses;
• Debt
• Equity

 Equity: Equity financing, involves raising capital by selling ownership

shares/stocks in the company to investors in exchange for their investment.
• Equity investors become partial owners or shareholders of the company and have
a claim on its assets and earnings.
• Equity financing can be obtained through various means, such as initial public
offerings (IPOs), private placements, venture capital, and angel investors.

• The advantage of equity financing is that it does not require repayment or

interest payments. Instead, investors share in the company's profits and may have
voting rights. However, selling equity dilutes existing ownership and control, and
shareholders may expect a share in decision-making and profit distribution.

Slide 3
 Introduction

• Debt: Debt financing involves borrowing money from external sources,

with the promise of repayment over time, typically with interest.

• The borrowed funds need to be repaid within a specified period, and the
borrower is obligated to make regular interest payments
• Common forms of debt financing include bank loans, corporate bonds,
trade credit,leasing,factoring,commercial paper,preference shares
• The advantage of debt financing is that the borrower retains ownership
and control over the company while benefiting from the tax-deductibility
of interest payments. However, taking on excessive debt can increase
financial risk- The likelihood that you might not be able to manage your
debt and associated interest expense.
 What is a Bond?
Definition
“A bond is a debt instrument requiring the issuer
(debtor or borrower) to repay to the investor (lender)
the amount borrowed plus interest over some specified
period of time”
- Frank Fabozzi

Slide 5
 What is a Bond?
• A bond is a debt instrument:
A bond represents a loan made by one party- the investor /lender to another party - the issuer /debtor or
borrower)

• Requiring the issuer to repay to the investor/lender amount borrowed plus interest: The issuer has a legal
obligation to repay the principal amount borrowed (the face value or par value of the bond) to the investor at
the bond's maturity.

• In addition to repaying the principal amount, the issuer also pays interest to the investor periodically. The
interest payments are based on the bond's coupon rate, which is typically a fixed percentage of the bond's
face value.

• Over some specified period of time: Bonds have a predetermined maturity date, which marks the end of the
bond's term. The period of time can range from few years to long-term (e.g., several decades) depending on
the bond's maturity.

• Overall, a bond represents a contractual agreement between the issuer and the investor, with the issuer
borrowing funds from the investor and promising to repay the borrowed amount plus interest over a
specified period of time.

Slide 6
 Bond Issuers
• Bond issuers are entities that are looking for financing and have issued bonds
to raise funds
• Four classes of issuers
– Governments: countries who run huge budget deficit require large amounts
of financing from global investors. Gov’t bond market are the deepest &
most liquid market globally. Eg. GoG Jubilee Bonds, $750m Sovereign Bonds
– Companies/corporates: assess the bond markets for debt financing as
opposed to equity to optimize their capital structure. Visit csd.com.gh for
issued corporate bonds
– Regions/municipalities: a very active bond issuers as most don’t have
access to equity market financing
– Supranationals/agencies: these are official agencies made up of several
member nations & enjoy varied levels of guarantees from their member
countries. e.g. WBG, AfDB
 Bond Types
Bond Types
 Century bonds  Eurobonds
 Plain vanilla bonds  Convertible  Green bonds
 Zero coupon bonds bonds  Dual
 Inflation-linked bonds  Callable Bonds
Currency
 Floating rate bonds  Samurai bonds Bonds
 Focus: plain vanilla bonds, the most common type. It pays

fixed amount of interest to the bond investor at regular time

intervals,
 Price: issued at par
 Coupon Rate: fixed throughout the term of GoG
security Bonds
 Coupon Payment: semi-annual from issue date
Features
 Tradable: bought/sold @ the secondary market
 Bond Types
Plain Vanilla Bonds: Plain vanilla bonds, also known as fixed-rate bonds, are the most common type
of bonds. They pay a fixed interest rate (coupon rate) at regular intervals until maturity. The principal
amount is repaid to bondholders at maturity. These bonds have a set maturity date and provide a
predictable stream of income to investors. Here are some key characteristics of plain vanilla bonds:

Fixed Interest Payments: Plain vanilla bonds pay a fixed amount of interest, known as the coupon
rate, to bondholders at regular intervals. The coupon rate is predetermined at the time of issuance
and remains constant throughout the life of the bond. The interest payments are typically made
semi-annually, although some bonds may have different payment frequencies such as annual or
quarterly.

Predictable Income Stream: Plain vanilla bonds provide a predictable income stream to
investors since the coupon rate and payment schedule are fixed. This makes them popular
among income-focused investors who desire a steady and reliable source of interest income.

Maturity Date: Plain vanilla bonds have a specified maturity date, on which the issuer is obligated
to repay the principal amount/ face value/ par value to the bondholders.

Fixed Principal Repayment: At maturity, bondholders receive the full face value of the bond- the
amount initially borrowed by the issuer- repaid in a single lump sum.
Slide 9
 Bond Types
 Credit Risk: The yield and creditworthiness of plain vanilla bonds are dependent on
the issuer's credit rating. Higher-rated issuers, such as governments or financially
stable corporations, generally offer lower coupon rates due to their lower credit
risk. Lower-rated issuers, on the other hand, typically offer higher coupon rates to
compensate investors for the increased credit risk.

 Secondary Market Trading: Plain vanilla bonds are often actively traded in the
secondary market, allowing investors to buy and sell them before their maturity.
The prices of these bonds in the secondary market can fluctuate based on changes
in interest rates, market conditions, and the creditworthiness of the issuer.

• Plain vanilla bonds are considered relatively low-risk investments, offering fixed
income and a known repayment schedule. They are suitable for investors seeking
stable returns and income preservation. However, it's essential for investors to
assess the creditworthiness of the issuer and carefully evaluate the terms and
conditions of the bond before making investment decisions.
Slide 10
 Bond Types

 Zero Coupon Bonds/Strips/Zeros: do not pay regular interest payments. Instead,

they are issued at a discount to their face value and mature at face value. The
investor earns interest by purchasing the bond at a discounted price and receiving
the full face value at maturity. Zero coupon bonds are popular among investors
seeking a predetermined return or for specific long-term financial goals.
 Inflation-Linked Bonds/ inflation-indexed / Treasury Inflation-Protected Securities
(TIPS), are designed to protect investors from the erosion of purchasing power
caused by inflation. The principal value are adjusted for changes in the inflation
rate, ensuring that the investment keeps pace with inflation.
 Floating Rate Bonds: interest rates vary over time based on a reference rate, such
as a benchmark interest rate (e.g., LIBOR) plus a spread. The interest payments on
these bonds are periodically reset, typically every three to six months, to reflect
current market rates. Floating rate bonds are designed to provide protection
against rising interest rates.

Slide 11
 Bond Types
 Century Bonds: also known as ultra-long-term bonds or 100-year bonds, have an exceptionally long
maturity period of 100 years. These bonds are issued by governments or corporations seeking long-
term financing. Century bonds offer the issuer a way to lock in long-term funding, while investors
benefit from potentially higher yields. However, these bonds carry significant interest rate and
inflation risk due to their extended duration.
 Convertible Bonds: give bondholders the option to convert their bonds into a predetermined
number of the issuer's common stock. This feature provides potential upside if the stock price rises,
as the bondholder can convert and participate in equity appreciation. Convertible bonds typically
pay fixed interest payments until conversion or maturity. They are attractive to investors seeking a
combination of fixed income and equity participation.
 Callable Bonds/redeemable bonds: have an embedded option that allows the issuer to redeem or
"call" the bonds before their maturity date. When a bond is called, the issuer repurchases the
bonds from bondholders at a predetermined call price. Callable bonds provide flexibility to issuers
to manage their debt obligations and interest rate risk. However, from the investor's perspective,
callable bonds carry the risk of early redemption and potential reinvestment at lower yields.
 Samurai Bonds: are yen-denominated bonds issued in Japan by foreign entities. They allow foreign
issuers to tap into the Japanese capital market and attract Japanese investors. Samurai bonds are
subject to Japanese regulations and are usually issued by non-Japanese corporations, supranational
organizations, or foreign governments.
Slide 12
 Bond Types
Eurobonds: Eurobonds are bonds issued in a currency different from the currency of
the country where they are issued. They are typically issued by multinational
corporations, sovereign entities, or international organizations. Eurobonds allow issuers
to tap into international capital markets and attract investors from different countries.
The currency of issuance is usually a major global currency such as the US dollar, euro,
or British pound.
Green Bonds: are specifically designed to finance projects with environmental or
climate-related –benefits- renewable energy, energy efficiency, sustainable agriculture,
waste management etc. Green bonds are issued by governments, municipalities, and
corporations to raise funds for environmentally friendly initiatives. They offer investors
an opportunity to support sustainable development and align their investments with
environmental goals.
Dual Currency Bonds/ currency option bonds /foreign currency exchange bonds: allow
investors to receive interest payments and principal in a currency different from the
currency of issuance. These bonds provide exposure to two different currencies,
offering investors the potential for currency diversification or speculation. Dual
currency bonds are more commonly found in Asian markets, particularly in Japan and
South Korea.
Slide 13
 Bond Types
Treasury Bonds: These bonds are issued by the government and are considered
the safest type of bonds. They have maturities ranging from 10 to 30 years and
pay interest every six months. Treasury bonds are backed by the full faith and
credit of the government.
Corporate Bonds: are issued by corporations to raise capital for various
purposes, such as expansion, acquisitions, or refinancing debt. They offer higher
yields compared to government bonds but also carry higher credit risk. Corporate
bonds have a wide range of maturities and may pay interest semi-annually or
annually.
Municipal Bonds/ or "munis,“: are issued by state and local governments or
their agencies to finance public infrastructure projects, such as schools, roads, or
hospitals. They offer tax advantages to investors, as the interest income is often
exempt from federal and sometimes state and local taxes.
Government Agency Bonds: These bonds are issued by government-sponsored
entities (GSEs) or federal agencies eg. Electoral Commision ,Ghana Stock
Excahnge. They are not backed by the full faith and credit of the government but
are considered relatively safe due to implicit or explicit
Slide 14 government guarantees.
 Bond Types
 High-Yield Bonds: also known as junk bonds, are issued
by companies with lower credit ratings. They offer
higher yields to compensate investors for the increased
credit risk. These bonds have the potential for higher
returns but also carry a higher risk of default.
 Foreign Bonds: are issued by foreign governments or
corporations in a currency different from that of the
investor's country. These bonds provide exposure to
international markets but also carry currency exchange
rate risk.

Slide 15
 Features of bonds/Bond Terminology
• Coupon Rate: The annual interest rate paid by the issuer to the bondholder, expressed as a
percentage of the bond's face value.
• Face Value (Par Value): The predetermined amount that the issuer promises to repay to the
bondholder at maturity. It is also the amount on which the coupon payments are based.
• Maturity Date: The date on which the bond reaches the end of its term, and the issuer is
obligated to repay the bondholder the face value.
• Yield to Maturity (YTM): The total return anticipated on a bond if held until maturity, taking
into account the bond's price, coupon payments, time to maturity, and face value.
• Call Provision: A feature in some bonds that allows the issuer to redeem the bond before its
maturity date. The issuer may exercise this provision when interest rates decline or to
manage their debt.
• Call Price: The price at which a bond can be redeemed by the issuer if a call provision is
exercised. It is often set at a premium over the face value.
• Put Provision: A feature that allows bondholders to sell their bonds back to the issuer before
maturity, usually at a predetermined price.
• Yield to Call (YTC): Similar to YTM, but it calculates the yield if a bond is called before its
maturity date.
Slide 16
 Features of bonds/Bond Terminology
• Coupon Payments:
– Bonds typically have fixed coupon payments, which are paid to bondholders at regular intervals, usually semi-annually.
– The bond issuer makes these interest payments to compensate bondholders for lending their money.
– The coupon payments are calculated based on the bond's face value and coupon rate.
• Call or Redemption:
– Some bonds may have call provisions that allow the issuer to redeem the bonds before their maturity date.
– If the bond has a call provision, the issuer can choose to retire the bond early, usually at a predetermined call price or a premium over the face value.
– Call provisions are included in bonds to provide flexibility to issuers in case interest rates decline or to manage their debt.
• Maturity:
– The maturity date is the end of the bond's life cycle when the issuer is obligated to repay the bondholder the face value (principal amount).
– On the maturity date, the bondholder receives the principal amount, and the bond ceases to exist.
– The bond's maturity period can range from a few months to several decades, depending on the terms set by the issuer.
• Bond Rating: An evaluation of the creditworthiness of a bond issuer by rating agencies such as Standard & Poor's, Moody's,
or Fitch. Ratings help investors assess the default risk associated with a bond.
• Investment-Grade Bonds: Bonds with high credit ratings (e.g., AAA to BBB- by S&P) indicating a lower default risk. They are
typically issued by financially stable entities.
• Junk Bonds: Bonds with low credit ratings (e.g., BB+ and below by S&P) indicating a higher default risk. They are associated
with higher yields to compensate for the increased risk.
• Yield Curve: A graphical representation of the relationship between bond yields and their respective maturities. It helps to
analyze the term structure of interest rates.
• Duration: A measure of the sensitivity of a bond's price to changes in interest rates. It helps assess the interest rate risk
associated with a bond.
• Bond Indenture: The legal agreement between the bond issuer and bondholder that outlines the terms and conditions of the
bond, including repayment terms, coupon payments, and any special features.
• Zero-Coupon Bond: A bond that does not pay periodic coupon payments but is issued at a discount to its face value. The
investor receives the face value at maturity.
Slide 17
 Features of GoG Bonds
 Price: issued at par/face value
 Coupon Rate: fixed throughout the term of security
 Coupon Payment: semi-annual from issue date
 Tradable: bought/sold @ the secondary market

Slide 18
 Life Cycle of a Bond
Simple representation of the life cycle of a 3-year bond
Purchase @ issuance
(primary market) Purchase in the
secondary market

Bond price
Par value
Bond Year 1 Year 2 Year 3 (maturity)
issuance

Coupon Coupon Coupon & principal

• The life cycle of a bond refers to the stages that a bond goes through from its issuance to its maturity.
• Origination and Issuance in the primary market: at par, key terms of the bond, including the face value, coupon rate, maturity date, and any
special features such as call provisions or convertible options. The bonds are underwritten by investment banks or financial institutions, who
assist in structuring and marketing the bond offering. The bonds are then offered to investors through a public offering or private placement
• Bond Trading in the Secondary Market: Once the bonds are issued and listed, they can be traded on the secondary market, such as stock
exchanges or over-the-counter markets. Investors can buy and sell bonds among themselves, and bond prices fluctuate based on changes in
interest rates, credit risk perceptions, and market conditions. Bond prices may be quoted as a percentage of the face value, and the interest
rate at which the bond is currently trading is referred to as the yield
• Investors will receive coupon payments every year for 3-years & get principal back at maturity upon purchase of bond
• Primary market transaction: where bond is bought at issuance
• Sec. mkt transaction: bond bought b/4 maturity but after issuance
• When one buys/sells a bond in the sec. mkt the transacted price is the market price of the bond at that time & is unlikely to be the par value of the bond
 Life Cycle of a Bond
Simple representation of the life cycle of a 3-year bond
Premium
Discount

Bond price
Par value
Year 1 Year 2 Year 3 (maturity

• If bond is issued @ GH¢100 par value & the price in the secondary
market=GH¢101. ⇒ bought it higher than par value = premium
• If purchased below par say at GH¢98 = discount
• While bond price=par value @ issuance & maturity it fluctuate
during the life of the bond due to
(i) inflation; (ii)market yield; (iii) economic health of issuer/sector
 Factors that have a significant impact on
the rate of bond interest
• Risk: The level of risk associated with a bond issuer affects its interest rate. Higher-risk bonds, such as those issued by
lower-rated companies or countries, generally offer higher interest rates to compensate investors for the increased risk of
default. Conversely, lower-risk bonds issued by financially stable entities tend to have lower interest rates.

• Maturity: The maturity of a bond refers to the length of time until it reaches its maturity date. Generally, longer-maturity
bonds carry higher interest rates compared to shorter-maturity bonds. This is because longer-term bonds expose investors
to a greater degree of interest rate risk and uncertainty.

• Liquidity: The liquidity of a bond refers to how easily it can be bought or sold in the market without significantly impacting
its price. Bonds that are more liquid, meaning they have high trading volumes and active secondary markets, typically
offer lower interest rates. Investors are willing to accept lower yields for the convenience of easily buying or selling their
bonds.

• Supply and Demand: The supply and demand dynamics in the bond market can influence bond interest rates. If there is
high demand for bonds relative to the available supply, bond prices tend to rise, leading to lower interest rates.
Conversely, if there is an oversupply of bonds in the market, bond prices may decline, resulting in higher interest rates.

• Inflation Expectations: Bond interest rates are influenced by inflation expectations. If investors anticipate higher future
inflation, they will demand higher yields to offset the expected erosion of purchasing power. As a result, bond issuers may
need to offer higher interest rates on their bonds to attract investors.

• These factors interact with each other and can vary across different bonds and market conditions. It's important for
investors to consider these factors when evaluating bond investments and to assess the potential risks and returns
associated with a particular bond. Slide 21