Case 003Bond issuance and executionWarm up

Mirashi Infra InvIT is issuing Rs 1,000 crore of five-year bonds. An anchor investor offers Rs 400 crore if the pricing is 10 basis points wider. Do you take it?

The situation

Mirashi Infra InvIT, an infrastructure trust holding toll roads, wants to raise Rs 1,000 crore of five-year bonds. The desk's initial guidance puts the yield at a level where it expects a comfortable book. A large insurer offers to anchor the deal with Rs 400 crore, but only if the yield is 10 basis points higher than guidance.

The bonds will price at one yield for every investor. The syndicate desk's honest read is that without the anchor there is about one chance in three that the book comes in thin and the deal has to price 20 basis points wider to fill. Use 7.5% to discount the extra cost.

Your task

What does the concession cost over the bond's life, what does it buy, and would you accept it?

Quick check

What does the 10 basis point concession cost Mirashi each year?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The concession costs Rs 1.0 crore a year, Rs 5.0 crore over five years, about Rs 4.0 crore in today's money. Without the anchor, the expected extra cost is one third of 20 basis points, about 6.7 basis points or Rs 0.67 crore a year. On those odds I would counter at around 5 basis points, and pay the full 10 only if a failed or shrunken deal would cost Mirashi more than the spread.

Step 1What does the concession really cost?

Picture a vegetable seller who agrees to cut the price for a bulk buyer at a market where every customer sees the same price board. The discount is not paid on the bulk buyer's bag alone; it is paid on everything sold that morning. Because the bond prices at a single yield, 10 basis points for the anchor is 10 basis points on all Rs 1,000 crore: Rs 1.0 crore a year. Over five years that is Rs 5.0 crore, or about Rs 4.0 crore discounted at 7.5%.

Step 2What does Mirashi get for that money?

It buys certainty. A 40% anchor makes the deal close to done before it opens, and a visible anchor often pulls other investors in, because nobody likes being the only buyer. Without the anchor, the desk's read is a two in three chance of filling at guidance and a one in three chance of pricing 20 basis points wider, an expected cost of about 6.7 basis points, or Rs 0.67 crore a year. So on average, the anchor charges more than the risk it removes: Rs 1.0 crore of sure cost against Rs 0.67 crore of expected cost.

The anchor sells certainty: compare a sure cost with a risky oneAccept the anchor at +10 bpsDecline and build the bookRs 1.0 crevery yearPaid on the wholeRs 1,000 crore, notjust the anchor's 400Life cost Rs 5.0 crPV at 7.5%: Rs 4.0 cr2 in 3:fills, Rs 01 in 3:+20 bps, Rs 2.0 crExpectedRs 0.67 cranchor cost
Accepting the anchor costs a certain Rs 1.0 crore a year on the full issue, while declining costs nothing two times in three and Rs 2.0 crore a year one time in three, an expected Rs 0.67 crore: on these odds the concession is priced above the risk it removes.
The relationship
accept if   10 bps<p×20 bps  ⇒  p>50%\text{accept if } \; 10 \text{ bps} < p \times 20 \text{ bps} \;\Rightarrow\; p > 50\%
10 bpsthe anchor's concession, paid on the whole issue
pthe chance the book comes in thin without the anchor
20 bpshow much wider a thin book would price
What it says in wordsOn spread alone, the concession pays only if a thin book is more likely than not.
Step 3When is paying the full 10 basis points still right?

When failure costs more than spread. An anchor concession is a price for certainty, so it should be sized against what uncertainty would cost the issuer, not against the average outcome. If Mirashi has a Rs 1,000 crore maturity in three weeks and no other funding, a failed or cut deal could mean an expensive bridge loan or a missed payment, and Rs 1.0 crore a year is cheap insurance. If Mirashi can wait a month, the same concession is an overpayment.

There is also a cost that is not in the spread. A single holder with 40% of the bonds can block amendments that need a majority, and may sell a large block later, which weighs on the bond's secondary price. Say both, then close: counter at 5 basis points, accept up to about 7 on these odds, and go to 10 only with a funding deadline that makes certainty worth paying for.

Where candidates lose it

The quick wrong answer costs the concession on the anchor's Rs 400 crore, Rs 0.4 crore a year, and calls it cheap. In a single-price book the whole issue reprices, which is two and a half times that figure.

The second miss is answering yes or no without the other side of the scale. The concession is insurance, and insurance is judged against the risk and the damage it covers. Name the odds and the cost of a failed deal, then decide.

What the interviewer asks next

  • The desk now thinks the chance of a thin book is one in two. What changes?
  • Could you give the anchor a better allocation instead of a better price?
  • How would the answer change for a ten-year bond?

Company names and figures are illustrative.