Governments
sell bonds of different types and durations to investors by way of an
auction process in order to finance their operations. These bond
auctions have become more and more important for our traders of late,
particularly in light of the peripheral European debt crisis. Each
government has its own process by which it sells bonds to the market.
However, the individual processes tend to be similar in nature which
allows our traders to interpret them effectively. Below is a summary of
the US Government ’s bond auction process which serves as a useful
template for other government bond auctions.
The US Government issues four different types of securities: Bills
(maturity of less than 1 year), Notes (maturity of 2, 3, 5, 7 or 10
years) Bonds (maturity of 30 years) and Treasury Inflation Protected
Securities (TIPs – 5, 10 and 30 years). These securities are sold by
way of an auction process that determines their rate or yield and
involves a 3-step process:
- Announcement
The Treasury announces a schedule of pending auctions together with the following:
- Amount to be auctioned
- Auction date
- Maturity date
- Terms and conditions of the offering
- Customers eligible to participate
- Non-competitive and competitive bidding closing times
- Auction
The
Treasury receives bids for the bonds in question from both institutions
and individuals. Bids are either non-competitive (you bid for and
receive that amount of bonds at the auction – up to a limit of $5
million – at the yield set at the auction) or competitive (you specify a
yield at which you wish to receive bonds but are not guaranteed to get
them. If your bid is less than or equal to the high yield determined at
the auction, you will receive your bonds; however, your bid may be
prorated if your bid equals the high yield.)
Direct
bidders are Primary Dealers and Financial Institutions that place their
bids directly with the Treasury. Indirect bidders represent those that
do not go through Primary Dealers. Indirect bids are assumed to be a
proxy for purchases by foreign central banks and used to draw inferences
about such banks’ continued willingness to buy government bonds.
- Issuance
At
the close of an auction, the Treasury accepts all non-competitive bids
and then accepts competitive bids in ascending order in terms of their
yields (lowest to highest) until the quantity of accepted bids reaches
the required amount. All bidders will receive the same rate or yield.
Auction Results
Upon the conclusion of a government bond auction the results are released including:
- Amount issued
- yield
- price
- Amount of competitive/non-competitive bids tendered/accepted
- Amount of direct/indirect bids tendered/accepted
- Bid/cover ratio – the total amount of bids tendered divided by those accepted
As
with all economic indicators, the financial markets and our traders set
expectations for how well or otherwise a bond auction will proceed. As
the results are released, the markets will react to the new information
until it is reflected in the price of the underlying securities and
other associated markets.
