What it means
Normally, a borrower creates a bond with a specific interest rate, called a coupon, and a repayment date, called maturity. A tap issue reopens that same bond and sells more of it.
The new bonds are identical to the old ones, so the market sees one bigger issue. The name comes from the idea of turning on a tap to let a little more out.
Governments, especially in the United Kingdom, have used the method for many years to sell government bonds called gilts. They can choose the timing and size of each sale to suit market conditions and avoid flooding the market.
A larger single issue is generally easier to buy and sell because there are more bonds in the market. This liquidity (the ease of trading without moving the price) makes investors willing to accept a slightly lower yield.
Issuers therefore benefit from fewer, bigger bonds in place of many small ones. The additional bonds are sold at the current market price, which may be above or below face value.
If market interest rates have risen since the original issue, the price will be lower than face value, so the issuer receives less than the amount it must repay. The coupon stays the same, so the effective cost of borrowing on the new bonds reflects today's yield.
For finance teams, tap issues show up in debt management plans and treasury reports. They are a way to raise funds in stages while keeping the debt profile tidy.
The main risk is that the issuer sells into a weak market and receives a poor price. Companies use the same technique, although it is most associated with governments.
A company that taps a bond avoids the legal and marketing work of launching a new one, which can save time and fees. It also keeps its list of outstanding bonds short, which investors and rating agencies find easier to follow.
In practice
Real-world examples.
Example
A national debt office wants to raise $500,000,000 over three months. It sells $100,000,000 of an existing bond each month using a tap. Each sale is announced in advance so investors can plan their purchases, and the office adjusts the amounts if demand turns out to be weak.
Example
A large utility has a 10-year bond in the market and needs another $300,000,000 for a new plant. Instead of creating a new bond, it sells more of the existing issue at the current price. Investors find the larger bond easier to trade.
Example
A city taps its own bond issue to fund a road project after the original sale raised less than planned. The additional bonds have the same coupon and maturity, so the city's repayment schedule stays simple. The city's finance director reports the combined size to the council.
Formula
Calculation
Proceeds from a tap = face value sold x (price / 100)
Total outstanding after the tap = existing face value + new face value
A government has $1,000,000,000 of 4% bonds outstanding. It taps the issue by selling a further $200,000,000 of face value at a price of 98, meaning 98% of face value. Proceeds = 200,000,000 x 0.98 = $196,000,000. Total outstanding after the tap = 1,000,000,000 + 200,000,000 = $1,200,000,000, and the annual coupon on the new bonds is 200,000,000 x 0.04 = $8,000,000. The government must repay $200,000,000 at maturity although it received $4,000,000 less today.Case study
Seen in the real world.
Northgate Treasury is an illustrative, fictional government debt office that issued a $2,000,000,000 bond paying a 3% coupon. A year later it needed another $400,000,000 and decided to tap the issue.
Market yields had risen, and the bond was trading at a price of 96. The tap raised 400,000,000 x 0.96 = $384,000,000, which was $16,000,000 less than the face value that must be repaid.
The illustrative debt office accepted the shortfall because the combined bond of $2,400,000,000 was easier to trade, and it saved the work of launching a new bond. Its finance team noted that the effective borrowing cost on the new bonds was higher than the 3% coupon suggested.
Watch out
Common mistakes.
- Assuming a tap raises exactly the face value of the bonds, when they are sold at the market price and may bring in more or less.
- Thinking the tap creates a new bond with a new coupon, when the bonds are identical to the existing issue.
- Forgetting that the extra bonds increase the total amount to be repaid at maturity.
Questions
People also ask.
What is the difference between a tap and a new issue?
A tap adds to an existing bond with the same terms, while a new issue creates a separate bond with its own terms.
Why do issuers like taps?
They are flexible, they build bigger and more liquid bonds, and they let the issuer raise money in smaller steps.
Do tap issues change existing bondholders' rights?
No, the new bonds carry the same coupon and maturity, though the larger issue size can affect how easily the bonds trade.
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