Operis has assumed that the Model operates correctly having been formally audited in the run up to the financial close and having been studied by the NAO and its advisors. Operis has not subjected it to an independent audit of its own. It is, however, prudent to verify one key issue, which is that altering the input that looks as though it controls the margin on the bond (the issue of interest in this paper) does actually affect the Model in the way one might expect.
To do this, Operis has performed the following analysis.
■ It has observed that the margin on the bond in the Base Case is 1.63%.15 That combines with the base rate of 1.952% to give a bond coupon of 3.582%.
■ It has calculated the cash flows that flow between the SPV and the bond holders. These amount to the initial injection of the bond proceeds, less the bond coupon (interest payments) and instalments of principal repayment.16
■ The IRR of these cash flows is 1.813% in nominal terms, but since the bond is index linked it is more useful to report its equivalent in real terms of 1.791%. Since the Model operates half yearly, these are semi-annual rather than annual rates. It can be demonstrated that the difference in rates is equivalent to an indexation factor of 2.5% compounding annually applied to the real terms rate.
■ The 1.791% can be reconciled to the bond coupon assumption as exactly half of 3.582%, the difference, again, being between the semi-annual rate used in the model and the annual rate conventionally quoted.
■ Operis has altered the bond margin by 10bp, shifting the overall bond coupon to 3.682%. The IRR of the lender cash flows becomes 1.841%; the semiannual figure again, exactly half the annual rate.
Operis concludes that it can reconcile the linkage between the bond cash flows and the bond margin exactly.
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15 This is at cell 'Assump' !B35 in the Model.
16 Lending banks charge fees when they arrange and commit to advance loans. The equivalent cost in the context of a bond issue is a discount to face value. No fee or discount has been included in this calculation, because the yield on the resulting cash flows would not then coincide with the interest rate, and the mathematical property on which this test is relying would cease to hold.