What is a Back Up?
A back up is an increase in a security’s price, yield, or spread before issuance.
In other circles, back up means replacing a long-maturity security with a short-maturity security in order to capitalize on short-term interest rates that are higher than long-term interest rates.
How Does a Back Up Work?
For example, let’s assume that Company XYZ wants to issue $100 million in 10-year bonds. The yields on bonds of similar quality and risk were about 5% when Company XYZ hired the underwriter to handle the bond issue, but since then the required yields have increased to 7%. This means Company XYZ has to issue the bonds at a bigger discount in order to keep the issue competitive, and thus it will obtain less cash from investors at the time of the sale.
This increase in the cost of issuing the securities is a back up.
Why Does a Back Up Matter?
Back ups can be very detrimental to issuers, especially if they are relying on a very specific amount of money to come from the issue, and even more especially if the company’s success hinges on the reinvestment of those funds.