Bond represents the capital provided by the long term fund providers of the firm.

Bond valuation is important to know the status how much the debt of the firm worth.

Important Learning Terms

Bond

Coupon Interest rate

Par value

Yield

Indenture

Mortgage bond

Eurobonds

Value

Bond Rating

Definitions and Characteristics of Bonds

A bond is a long-term promissory note that promises to pay the bondholder a
predetermined, fixed amount of interest each year until maturity. At maturity, the
principal will be paid to the bondholder.
In the case of a firm's insolvency, a bondholder has a priority of claim to the firm's
assets before the preferred and common stockholders. Also, bondholders must be
paid interest due them before dividends can be distributed to the stockholders.
A bond's par value is the amount that will be repaid by the firm when the bond
matures.
The contractual agreement of the bond specifies a coupon interest rate that is
expressed either as a percent of the par value or as a flat amount of interest which
the borrowing firm promises to pay the bondholder each year. For example: A $1,000
par value bond specifying a coupon interest rate of 9 percent is equivalent to an
annual interest payment of $90.
The bond has a maturity date, at which time the borrowing firm is committed to
repay the loan principal.
An indenture (or trust deed) is the legal agreement between the firm issuing the
bonds and the bond trustee who represents the bondholders. It provides the specific
terms of the bond agreement such as the rights and responsibilities of both parties.
The current yield on a bond refers to the ratio of annual interest payment to the
bonds market price

Types of Bonds
Debentures: unsecured long-term debt.
Subordinated debentures: bonds that have a lower claim on assets in the event of
liquidation than do other senior debtholders.
Mortgage bonds: bonds secured by a lien on specific assets of the firm, such as real
estate.
Eurobonds: bonds issued in a country different from the one in whose currency the
bond is denominated; for instance, a bond issued in Europe or Asia that pays interest
and principal in U.S. dollars.
Zero and low coupon bonds allow the issuing firm to issue bonds at a substantial
discount from their $1,000 face value with a zero or very low coupon.

The disadvantages are, when the bond matures, the issuing firm will face an
extremely large nondeductible cash outflow much greater than the cash inflow
they experienced when the bonds were first issued.

Discount bonds are not callable and can be retired only at maturity.

On the other hand, annual cash outflows associated with interest payments
do not occur with zero coupon bonds.

Junk bonds: Bonds rated BB or below by the credit rating companies.

Bond Ratings
Bond ratings are simply judgments about the future risk potential of the bond in
question. Bond ratings are extremely important in that a firms bond rating tells
much about the cost of funds and the firms access to the debt market.
Three primary rating agencies existMoodys, Standard & Poors, and Fitch Investor
Services in the United States.

Value
Definitions of value
Book value is the value of an asset shown on a firm's balance sheet which is
determined by its historical cost rather than its current worth.
Liquidation value is the amount that could be realized if an asset is sold individually
and not as part of a going concern.
Market value is the observed value of an asset in the marketplace where buyers and
sellers negotiate an acceptable price for the asset.
Intrinsic value is the value based upon the expected cash flows from the investment,
the riskiness of the asset, and the investor's required rate of return. It is the value in
the eyes of the investor and is the same as the present value of expected future cash
flows to be received from the investment.
Valuation: An Overview
Value is a function of three elements:
The amount and timing of the asset's expected cash flow
The riskiness of these cash flows
The investors' required rate of return for undertaking the investment
Expected cash flows are used in measuring the returns from an investment.

If interest payments are received semiannually (as with most bonds) the valuation
equation becomes

Bondholder's Expected Rate of Return (Yield to Maturity)

The bondholder's expected rate of return is the rate the investor will earn if the bond
is held to maturity, provided, of course, that the company issuing the bond does not
default on the payments.
Computing Yield-to-Maturity on a Bond (YTM)

Note: The investor uses the bond's computed YTM by comparing it to his/her
required rate of return on the bond after considering all risk factors.
1) If the investor's required return is greater than the YTM, the investor should not
buy the bond
2) If the investor's required return is less than the YTM, the investor should buy the
bond

Bond Value: Three Important Relationships

First relationship
A decrease in interest rates (required rates of return) will cause the value of a bond
to increase; an interest rate increase will cause a decrease in value. The change in
value caused by changing interest rates is called interest rate risk.
Second relationship
1. If the bondholder's required rate of return (current interest rate) equals the
coupon interest rate, the bond will sell at par, or maturity value.
2. If the current interest rate exceeds the bond's coupon rate, the bond will sell
below par value or at a "discount."
3. If the current interest rate is less than the bond's coupon rate, the bond will sell
above par value or at a "premium."
Third relationship
A bondholder owning a long-term bond is exposed to greater interest rate risk than
when owning a short-term bonds.

Relationships on the YTM

Since the bond's coupon rate, kc, is fixed for the life of bond, the following \
YTM/bond price relationship is created:

Discussion Questions
1. Telecom Tanzania Ltd issued a 20 year bond with a coupon rate of 9%, selling to
yield 12% interest rate ear annum. Calculate
a) The price of the bond
b) If the financial analyst in the Tanzania Communication Commission suggests that
the yield basis should be 10%, what is the price of the new bond?
2. TeleCel (Botwsana) Ltd. issued two bonds A and B. Both carry coupon rates of 8%
and both require a yield to maturity of 8%. Bond A have 5 years to maturity while
bond 10 years to maturity. The required market yield for each bond rises by 2
percentage points. Compare the percentage price changes for the two bonds.
3. SamSon Telecoms Ltd, a Subsidiary of Samwel Mollel and Sons Inestment Ltd in
Zimbabwe; issued bonds in 1987 at $1,000 per bond. The bond had a 30 year life
when issued and the annual interest payment was then 11%. The return was in line
with required returns by bondholders at that point as described below.
4.
Rate of return 3%
Inflation premium 5
Risk premium 3
Total return 11%
Assume in 2002 the inflation premium was only 2% and it is appropriately reflected
in the required rate of return (or yield to maturity) of the bonds. The bonds have
remaining 15 years to maturity. Compute the market price of the bond.
5. Explain why do you think it is important that the telecommunication regulator
should understand the concept of capital structure and value of the firm.
What is
(i) Financial Leverage
(ii) Gearing
6. How the firm should balance between financial gearing and the capital structure of
the firm?
Learning Activities
Individual
(1) Discuss with collegues how does the concept of cost of capital affect the value of
a telecommunication company? Present your solution on a discussion forum.
(2) Search in the internet leasing case studies relating to telecommunication.
Summarize the case by presenting the core issues in the case. Summarise what are
the important leaning points. In your own opinion why do you think many
telecommunication or ICT companies do not like to use leasing a source of financing
their activities?. Cases can be selected from any continent. Present the summary in
the discussion forum. The summary should not be more than five (5) pages of font
12 time series roman