U.S. Treasury Securities

Treasury Auctions

The U.S. Treasury issues securities in a public auction process.  The process is designed to minimize costs to the federal government and (over time) and efficiently finance its debt. In 2010, there were 301 U.S. Treasury auctions with about $8.4 trillion worth of debt issued.

Announcement and the When-Issued Market

Auction announcements appear in newspapers and other media a number of days before the actual auction; they include the value of the security, its issuance and maturity dates, the auction date, the terms of the offering, close times for bidding, and any other important information.

Before auctions take place, transactions occur in the “when-issued market”, in which deals are made to buy and sell securities on the issue date. The when-issued market provides important information about the prospective value of the security to potential bidders.

Dealers are permitted to “pre-sell” Treasury securities that have been announced but not yet auctioned or issued to their clients in the when-issued market. The rational is that this process lowers the cost of funds for the Fed. If dealers are able to get a sense of demand and price levels of the security, they would submit more aggressive bids (higher prices) at the Treasury auction, thereby lowering the interest the Fed needs to pay.

Bidding

Bids, which may be “competitive” or “noncompetitive”, are received by the Treasury‘s Bureau of Public Debt, Treasury Direct, and Federal Reserve Branches and Banks.

In a competitive bid, the bidder names the yield or rate he will accept and as well as the amount of the security he hopes to purchase. If this yield falls within the range of those accepted, he is sold this quantity, unless his is the “stop-out yield,” or the highest yield accepted. Individual bidders may bid competitively for up to 35% of the security’s offering amount.

In contrast, noncompetitive bidders agree to buy the security at the yield determined by the auction and receive the quantity of security they seek. Noncompetitive bidding is restricted to $5 million per auction.

Institutional investors are more likely than individual investors to bid competitively. This is because institutional investors tend to be more familiar with the auction process, and are thus more able to make successful competitive bids. They are also more likely to purchase more than the $5 million limit on competitive bidding.

When an auction closes, the Treasury first sells to the noncompetitive bidders. The total quantity of this sale is subtracted from the initial offering to determine the range of yields that will be accepted. Then competitive bids are taken in the ascending order of their yields (starting with the lowest interest rate specified) until the stop-out yield is reached. Bids accepted at this price are prorated, or allocated proportionately, so that the amount of security issued does not exceed the amount being offered. Competitive bids of yields higher than the stop-out yield are not accepted.

The Treasury auctions its securities using the “uniform-price method.” This means that both competitive and noncompetitive bidders purchase securities at the stop-out yield. Thus, the stop-out yield is also the discount, if the security is a bill, or the coupon, if the security is a note, bond, or TIPS.

The uniform price method avoids the “winner’s curse” that can occur using the multiple price method—the winner pays more than less aggressive bidders for the same asset and may be discouraged as a result. Thus, the uniform price method helps to encourage aggressive bidding and drive the price of securities up (a good thing for the U.S. Treasury).

Here is an example of an auction for a $100 Treasury Bill from the Federal Reserve Bank of New York website:

NAME	BID PRICE	(DISCOUNT) YIELD	AMOUNT
Bidder 1	$987.16	(5.08%)5.22%	$3.5 billion
Bidder 2	$987.13	(5.09%)5.23%	$2.5 billion
Bidder 3	$987.11	(5.10%)5.24%	$3.0 billion
Bidder 4	$987.11	(5.10%)5.24%	$3.0 billion
Bidder 5	$987.08	(5.11%)5.25%	$2.0 billion
Bidder 6	$987.06	(5.12%)5.26%	$1.0 billion

The Treasury is offering $11 billion of the security. Let us assume that noncompetitive bids totaled $1 billion. Thus, $10 billion in T-Bills will be issued to competitive bidders. The Treasury works its way down this chart, in ascending order of yield. Bidder 1’s bid is accepted ($6.5 billion is left). Then Bidder 2’s bid is accepted ($4 billion is left). Bidder 3 and Bidder 4 both bid the same price (and thus the same discount or yield). There is not enough security left to satisfy each of their $3 billion bids, but the Treasury wants to sell the remaining $4 billion. The remainder is split proportionately: Bidder 3 and Bidder 4 will both receive $2 billion. Every bidder buys the security at $987.11 (a yield or discount of 5.10%).

Bidder 1 and Bidder 2 get the security at a better price than they were willing to pay and are not negatively reinforced for bidding aggressively.

Primary Dealers

Only a limited number of institutional investors can buy securities at auction; these banks are known as the Primary Dealers, who may buy bid on behalf of their customers or for their own accounts. Primary dealers are not only permitted but also required by the Federal Reserve to participate in treasury auctions as well as the Fed’s open market operations. This is the Federal Reserve Bank of New York’s list of Primary Dealers:

BNP Paribas Securities Corp.
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Capital Markets America Inc.
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
HSBC Securities (USA) Inc.
Jefferies & Company, Inc.
J.P. Morgan Securities LLC
MF Global Inc.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
Mizuho Securities USA Inc.
Morgan Stanley & Co. LLC
Nomura Securities International, Inc.
RBC Capital Markets, LLC
RBS Securities Inc.
SG Americas Securities, LLC
UBS Securities LLC

Other banks, regardless of their size, may not participate in auctions and can only buy securities in the secondary markets. Somewhat ironically, any individual investor can purchase treasuries in the primary market for his or her personal account. So while Capital One cannot participate in treasury auctions, you and I can. (Banks that are not Primary Dealers may still be active traders of treasury securities in the secondary market).

Auction Schedule

Treasury auctions occur on a regular, predictable schedule.

The 4-, 13-, and 26- week Treasury Bills are issued weekly; the 52-week T-Bill is issued every 4 weeks.

The 2-, 3-, 5-, and 7-year Treasury Notes are issued monthly. 10-year Treasury Notes that are being issued for the first time are auctioned in the February, May, August, and November. Those that are being reopened (as 2-, 3-, 5-, and 7- year Notes) are auctioned during the remaining 8 months.

Similarly, 30-year Treasury Bonds being issued for the first time are auctioned in February, May, August, and November; those that are being reopened are auctioned once every other month.

5-, 10-, and 30-year Treasury Inflation Protected Securities (TIPS) are auctioned quarterly.

The auction schedule is not random; it is engineered so that auction dates coincide with securities’ maturity dates, so that firms and individuals can easily reinvest their money after the Treasury has repaid the principal on the debt.

Re-Openings

The auction schedule also allows makes it so that securities can be “reopened,” a phrase you may have noticed above. The concept of the “reopened” security is best understood by example: The 13- and 26-week Treasury Bills are auctioned every week. After 13 weeks have elapsed, the old 26-week T-Bill has 13 weeks left to mature. The Treasury is also having its regular auctions of 13- and 26-week bills. Instead of creating a new 13-week bill, the Treasury “reopens” the original 26-week bill, with an effective maturity of 13 weeks, and simply auctions more of it.