How do you price a bond and decide maturities?
Hey, so I was given a case study to prepare which is about calculating the interest rate a sovereign (A+) would have to pay on $5bn which it needed to build something over 12 years. 20% is needed in q1. I was just wondering what type of maturities I would use and what interest rates too? I was considering using US treasury 2 year rates for the 20% but got confused about what to do after any help would be greatly appreciated!
bump
first i would inquire what would be the useful life of the project (how long do they expect the project to last after it is built), and if it would create any cashflow (like a bridge with a toll...or an airport with lease fees).
Then i would askif they can structure the borrowing to take place in the future, for future needs. Why pay interest borrow now if 80% of the money will sit in a bank account for 5 years until its needed.
Then figure out how long it would take for the cashflows from the project to cover the cost of the debt. This is a simple amortization table.
if the project will take 12 years to build, then i would estimate that the maturity would be something like 30 years...and so you are looking at 30 year interest rates.
Also, you don't get to decide what interest rate you will pay..the market decides...usually some spread over treasuries, depending on the credit risk of the entity. If its Turkey borrowing the money, they will pay a higher rate than Canada...so then lookup relative interest rates to determine what the market spreads are.
great thanks for that really appreciate it! Its for a bridge but I never thought to mention tolls as it doesn’t give any potential cash flows. Would you have any idea on the fees that are typically charged by banks as it asks this in the question. I read somewhere it’s around 0.7% but I’m not certain if that’s right.
Just use 1%, it’s likely lower but this would cover all underwriters discount and cost of issuance likely
This is irrelevant if it’s sovereign debt as opposed to a single entity project financing (which your suggestion more relates to)
If this was a project financing this is still wrong. You would want to know the length of time of construction to revenue production and receive some type of construction loan or you can look into the delayed draw PP market assuming revenue is within 3 years. From there you’ll structure your debt around the revenues of the project given various debt covenants and desires from rating. Then you will typically price off the average life of that structure. So if the average live was 16 years you would use an interpolated 16 year UST and use some credit spread (say 150 bps) plus a premium if the delayed draw is used (35 bps).
On the construction loan structure you would need some type of construction to perm financing at the end of the interim (contraction financing) that would be used to take out the loan and fix it out long term. With this you assume interest rate risk until the perm financing although there are hedging products that could mitigate it. Problem is there’s no chance you’d get a 12 year on that so there’s got to be more information needed
Probably not project finance desk. Just look at the treasury, it should be fairly flat yield curve out to the 10's.
Look at historical UST yields see which points are at near lows, price at that + the closest sovereign bond comparable (accounting for rating/location) + 1-2bps New issue concession.
Probably propose laddered bond issuance to minimize refi risk and diversify buyer base (historically 10 year part of the curve probably gets most buyers) and also bit of execution risk when doing $5bil in one tenor for a new issuer.
I would propose something like:
10 year, 5 year, 2 year bullets initially then as construction ramps up issue more debt to make something like a synthetic amortized depending on how rates move
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