An issuer has 5-year and 7-year bonds trading. Set initial price thoughts and a final yield for a new 6-year bond, allowing a new issue premium.

Fair value is about 7.95%, the midpoint of Tejasvi's own 5-year and 7-year yields; add the 10 basis point premium and the bond should price near 8.05%. Initial price thoughts would go out around 8.20%, then guidance tightens as the book builds. 8.05% is a spread of 90 basis points over the 6-year government yield, and matches the 7-year's yield for a year less risk, which is the premium doing its job.

If you want to price a 6-room flat in a building where 5-room flats sell for Rs 85 lakh and 7-room flats for Rs 1.05 crore, you start from the flats in the same building, not the city average. A new bond is priced first from the issuer's own trading bonds, because they already carry the market's view of this credit. Six years sits halfway between five and seven, so interpolateEstimate a value between two known points by assuming a straight line between them.: halfway between 7.85% and 8.05% is 7.95%. The government curve checks the answer: Tejasvi's spread is 75 basis points at 5 years and 85 at 7, so 80 at 6 over a government yield of 7.15% gives the same 7.95%.

Investors who already own Tejasvi's 5-year or 7-year bonds have to sell something to buy the new one, and new investors take the risk that the deal is priced too tight. The new issue premiumThe extra yield a new bond offers over where the issuer’s existing bonds imply it should trade, to draw investors into the deal. is the price of moving that money, and 10 basis points here makes the new 6-year yield as much as the existing 7-year. Initial price thoughts start wider, around 8.20%, so that investors feel the price move in their favour as guidance tightens, and so the syndicate learns price sensitivity from the orders. Guidance might then move to around 8.10% and the final to 8.05% if the book is well covered.

Say the limits of the method too. Interpolation assumes the issuer's curve is a straight line between the two points, which is close enough over two years but not over ten. The existing bonds may be illiquid or trade at a premium for index inclusion, so check recent trades, not just quotes. And if the book is several times covered at guidance, the syndicate can tighten further and give back part of the premium; if orders are thin, it holds the premium or widens. The issuer's question is always how much it is paying above fair value; the answer here is 10 basis points a year, Rs 10 lakh a year for every Rs 100 crore issued.