What is a bill auction?
A bill auction is a public auction, held weekly by the U.S. Treasury, of federal debt obligations—specifically, Treasury bills (T-bills), whose maturities range from one month to one year. As of May 2021, 24 authorized primary dealers must participate in the auction and bid directly on each issue. A bill auction is how all U.S. Treasury bills are issued.
Understanding a Bill Auction
The weekly bill auction is an electronic Dutch auction. In this sort of proceeding, investors bid for the amount of the offering they are willing to buy in terms of quantity and price. The best bid wins, of course, but the offering’s price is set after all the bids are taken in and sorted instead of rising sequentially as bidders consecutively counter each other.
To kickstart the process, an announcement is released several days before the auction is to occur. The announcement includes the auction date, issue date, amount of securities sold, bidding close times, participation eligibility, etc. Bids are accepted up to 30 days in advance.
Once it begins, the bill auction accepts competitive bids to determine the discount rate to be paid on each issue. A group of securities dealers (banks and brokerages), known as primary dealers, are authorized and obligated to submit competitive bids on a pro-rata share of every Treasury bill auction.2 The winning bid on each issue will determine the interest rate paid. Once an issue is purchased, the dealers can hold, sell, or trade the bills. Market and economic conditions determine the demand for T-bills at auction.
Who participates in a Bill Auction?
Participants in any Treasury auction consist of retail investors and institutional investors who submit bids categorized as competitive or non-competitive tenders. Smaller investors submit non-competitive tenders. In effect, these investors are bidding a bit blind: While they are guaranteed to receive bills, they won’t know the exact final price or what discount rate they will receive until the auction closes. An investor who places a non-competitive bid consents to accept the auction’s competitive side’s decision on the final discount rate.
More prominent investors, such as institutional investors, submit competitive tenders. Each bidder is limited to 35% of the offering per bill auction.5 Each bid submitted specifies the lowest rate or discount margin the investor will accept for the debt securities. The bids with the lowest discount rate will be accepted first. The lowest discount rate that meets the supply of sold debt is the “winning” yield or the highest accepted yield after all non-competitive bids have been subtracted from the total amount of securities offered.3
Unlike non-competitive bidders, competitive bidders are not guaranteed to receive any T-bills, as approval of their bid depends on the discount yield they offer to accept. If their offered price is too low, they may get locked out. All competitive and non-competitive investors who bid at or above the level of the winning yield receive securities with this discount rate.
How a Bid Auction Works
For example, suppose the Treasury seeks to raise $9 million in one-year T-bills with a 5% discount rate. (The minimum amount you can buy a bill for is $100, although the most commonly sold bills have a par between $1,000 and $10,000.) Let’s assume the competitive bids submitted are as follows:
$1 million at 4.79%
$2.5 million at 4.85%
$2 million at 4.96%
$1.5 million at 5%
$3 million at 5.07%
$1 million at 5.1%
$5 million at 5.5%
The bids with the lowest discount rates will be accepted first since the government prefers to pay investors lower yields. Since the Treasury is looking to raise $9 million, it will accept the bids with the lowest rates up to 5.07%. At this mark of 5.07%, only $2 million of the $3 million bid will be approved. All bids below the 5.07% rate will be accepted, and bids above will be rejected. This auction is cleared at 5.07%, and all successful competitive and non-competitive bidders receive the 5.07% discount rate.
On issue day, the Treasury delivers T-bills to non-competitive bidders who made their submissions in a bill auction. In exchange, Treasury charges the accounts of those bidders for payment of the securities. The purchase price of the T-bill is expressed as a price per hundred dollars.
Conclusion
- Treasury bills are issued through an electronic bill auction, which the government conducts every week.
- The bill auction is open to the public, both institutional and individual investors; 24 primary dealers—financial institutions and brokerages—must participate.
- Participants are divided into competitive and non-competitive bidders. The competitive bids determine the discount rate for each T-bill issue. Non-competitive bids are sure to receive their securities, but they must agree to the competitive bids’ price.
- The lowest discount rate that meets the supply of sold debt is the “winning” yield.
