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Treasury Auctions and the Secondary Treasury Market

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Treasury Auctions: A Brief History Treasury issuance of war bonds began as an effort to

cover anticipated WWI debt 1917 No outside countries available to borrow from so the debt had

to be financed internally Rate and maturity fixed by the government

After the war more bonds were issued to cover those now reaching maturity Again government price fixed Oversubscription showed government was overpaying for or

undervaluing its debt Auctions were then implemented (1929) to allow for the

market to determine the true value of the issued securities

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What’s the Prize? Why Auction?

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Treasury Auctions: The Basics

Treasury Securities Most liquid (readily

tradable) Highest volume of debt in

the world Continually supported by

the issuance of new securities

Allows for market demand to set the yield.

Auctions reveal market interest indicated by the “bid-to-cover” ratio.

Treasury department controls timing and quantity of new issues

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Types of Securities

Treasury Bills

• Discount Security

• Maturity: 1 Year or Less

Treasury Notes

• Coupon Security

• Maturity: 2-10 Years

Treasury Bonds

• Coupon Security

• Maturity: Longer than 10 Years

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Auction Cycles: What and When Treasury Bill Auctions (Discount)

3 and 6-month bills every week 1-year bills every 4 weeks

Treasury Note Auctions (Coupon) 2 and 5-year notes monthly 10-year notes quarterly

Treasury Bond Auctions 30-year bonds quarterly

Reopened Issues Increasing amounts of outstanding issues

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The Auction ProcessDeclaration of Auction

Treasury Offering• Term and Amount Reported• Date of auction and bid

submissions declared

Submission of Bids

Primary Dealers• Certified by the US Treasury• Begin as a reporting dealer

Awarding of Securities

Auction Ends and Stop Yield is Reached• Bids arranged from lowest to

highest yield or highest to lowest price

• All bidders below stop yield receive the same yield rate

• bidders at SY are prorated with remaining securities

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The Auction Process

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• Bid below the “stop yield”

• Regardless of yield bid all winners receive the SY rate

Competitive

• Limited amount of securities allotted for non- competitive bids

• Have no say in the SY value

Noncompetitive

• Bid above the SY and “shut out”

• Bids recorded for the bid-to-cover ratio

Losers

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Secondary Treasury Market Trading of outstanding Treasury securities by a group of

specialized dealers. “On-the-run” issues replace “off-the-run” issues When issued market – trading prior to Treasury issuance

NOTE ON BILL QUOTES:

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Secondary Market: Repos “Repurchase agreements” for treasury securities Helps the Federal Reserve control short term interest rates Helps dealers of securities manage liquidity Like a loan, however the ownership of the security actually

changes hands from buyer to seller

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Dealer Borrows Cash

Seller Receives Security as Collateral

Dealer Buys Back the SecurityRepo:

Reverse Repo:

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Repo Terminology Term Repo vs. Overnight Repo Reversing In vs. Reversing Out Securities Selling Collateral vs. Buying Collateral Repo Rate: Short term loan interest (cost of financing)

Government Repo System and Customer Repo NOT Buying Collateral Matched Sale NOT Selling Collateral

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Questions….. And Maybe Answers

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Works Consulted Wikipedia…. Duh Yahoo Finance Foundations of Financial Markets and Institutions – Fabozzi,

Modigliani, and Jones Three OSU Finance Professors: to be specifically named

based on the quality of the preceding presentation

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