Tap Issue: Definition, How It Works, Benefits, and Examples
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Summary:
A tap issue, also known as a bond tap or tap sale, is a method that allows borrowers to sell bonds or short-term debt instruments from past issues at their original terms but at current market prices. This article explores the definition of tap issues, how they work, their benefits, considerations for investors and issuers, real-world examples, key takeaways, and article sources.
What is a tap issue?
A tap issue is a procedure that allows borrowers to sell bonds or other short-term debt instruments from past issues. The bonds are issued at their original face value, maturity, and coupon rate but are sold at the current market price. A tap issue is also referred to as a bond tap or tap sale.
How a tap issue works
When a bond is issued, it is made available in the public markets for lenders and investors to purchase. However, before a bond can be issued, it has to be authorized by the issuer. Sometimes, a portion or the full amount of the bond that is authorized is held back until the issuer needs the funds that the bond will provide when sold. When the bond is issued to the public at a later date, it is referred to as a tap issue.
Tap issues, which help avoid transaction and legal costs, are ideal for smaller fundraising attempts, where fundraising can be cost-prohibitive.
Benefits of a tap issue
A tap issue is usually a government security, such as a Treasury bill. The borrowing issuer announces the availability of the issue and accepts bids for a specified time period. The issue is sold at a fixed price or for a price dependent on the demand for the debt instrument. If the price is fixed, the security’s price will not appreciate in the secondary market and, thus, the issuer will be stuck paying a higher yield than would otherwise be necessary.
With a tap issue, the borrowing governmental body issues bonds over a period of time, rather than in one auction sale. A tap issue allows the government to make the bond available to investors when market conditions are most favorable. It is also an attractive mechanism for issuers as it provides for timely access to funds.
The bond tap is sold at the current market value on their issuance dates but issued under the same terms—face value, maturity date, coupon rate—as the initial series of bonds. Since the bond is priced at its market value, an issuer is able to offer the bonds at a premium to par if the bonds are trading attractively on the open market. And since a premium bond has a lower yield compared to a discount bond, the borrowing issuer will be in an advantageous position as it would be paying a lower return to investors.
Furthermore, by offering a bond with the same terms as its initial series, the issuer can lock in covenants, redemption schedules, and interest payment dates.
Real-world examples
- United States Treasury securities: The U.S. Treasury often utilizes tap issues to manage its debt and fund government operations. Treasury bills, notes, and bonds are issued through tap sales, allowing the government to adjust the supply of securities based on market demand while maintaining consistent terms for investors.
- Corporate bonds: Companies may also employ tap issues to raise additional capital without incurring the costs and administrative burdens associated with new bond offerings. By tapping into existing bond series, companies can efficiently access funding when market conditions are favorable.
Special considerations
This method of issuing additional debt was adopted by the British and French governments. Tap issues allow an organization to avoid certain transactional or legal costs and expedite fundraising. The issuer bypasses many of the initial formalities surrounding a bond issue, such as the prospectus, and proceeds to auction off the new securities. Issuing on tap is often suited for smaller fundraising attempts, where the cost of a new issue is too high when compared to the amount borrowed.
The bottom line
In conclusion, tap issues provide a valuable tool for borrowers, especially governmental bodies, to efficiently access funds from existing bond series at current market prices. This method offers flexibility in fundraising while maintaining consistency in terms for investors. While tap issues offer benefits such as timely access to funds and cost-effectiveness, they may also present limitations, including higher borrowing costs and suitability primarily for smaller fundraising attempts. Understanding tap issues and their implications is essential for both issuers and investors navigating the world of fixed-income securities. By considering the pros and cons, exploring real-world examples, and addressing key considerations, stakeholders can make informed decisions regarding tap issues in their financial strategies.
Frequently asked questions
What is the difference between a tap issue and a new bond issue?
A tap issue involves selling bonds from past issues at current market prices, while a new bond issue involves issuing bonds for the first time at face value.
How are tap issues beneficial for issuers?
Tap issues allow issuers to avoid certain transactional and legal costs associated with new bond issues and provide timely access to funds when market conditions are favorable.
What types of securities commonly use tap issues?
Government securities, such as Treasury bills, commonly use tap issues to make bonds available to investors when needed.
Can investors purchase bonds through a tap issue?
Yes, investors can purchase bonds through a tap issue, which allows them to buy bonds at current market prices without waiting for a new bond issue.
Are tap issues suitable for large fundraising attempts?
Tap issues are typically more suitable for smaller fundraising attempts due to their cost-effectiveness compared to new bond issues.
Key takeaways
- Tap issues allow borrowers to sell bonds from past issues at current market prices.
- They provide timely access to funds and flexibility in fundraising for issuers.
- Tap issues are commonly used for government securities like Treasury bills.
- Investors can purchase bonds through tap issues, which are typically cost-effective for smaller fundraising attempts.
- Tap issues may result in higher borrowing costs and are limited in scope compared to new bond issues.
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