Thursday, October 3, 2013

A Bond Pricing Mistake

Everyone makes mistakes, even finance professionals. It was recently revealed that Goldman Sachs mispriced a Ford bond issue. Bond issuers usually price (set the coupon rate) by adding a risk premium to the YTM of a similar maturity Treasury bond. In this case, Goldman Sachs used a Treasury bond that was just issued the same week. This is called the "on-the-run" Treasury issue and will have a slightly different price, in part because it is the most actively traded Treasury near that maturity. As a result of using the on-the-run Treasury instead of the Treasury that was previously issued, it costs Ford $1.5 million in additional interest payments over the life of the bond. As a result, Goldman Sachs lowered its fee from the 35 basis points it charged on Ford's previous bond issue to 25 basis points, a savings in underwriting expenses of $1 million.