What it means
The US Treasury, which is the government's finance department, borrows money by selling securities on a published calendar. Short-term bills mature in a year or less, notes run from two to ten years, and bonds run out to thirty years.
Investors submit bids through banks and dealers, and bids come in two forms. A competitive bid names the yield the bidder will accept, while a non-competitive bid simply agrees to take whatever yield the auction produces.
Smaller investors and many individuals use the non-competitive route and are filled first. Treasury auctions use a single-price format, which means every successful bidder pays the same price regardless of what they bid.
The lowest-yield bids are accepted first and the process continues until the whole amount is sold; the highest yield accepted becomes the yield everyone receives. Businesses follow the results because the auction yield acts as a benchmark for pricing loans, bonds and mortgages.
A weak auction, where demand is thin and yields have to rise to attract buyers, can push borrowing costs up across the economy. A strong auction tends to do the opposite.
The standard demand measure is the bid-to-cover ratio, which divides the total value of bids received by the amount on offer. A ratio of 2.5 means investors bid for two and a half times what was for sale.
Analysts compare it with recent auctions rather than reading it on its own. One nuance is that bills are quoted on a discount basis, which understates the true return.
Bills are sold below face value and repay the full face value at maturity, so the discount rate and the investment yield differ. A treasurer comparing bills with other short-term investments should convert everything to a like-for-like yield first.
In practice
Real-world examples
Example 1
A manufacturer holds $5,000,000 of spare cash for a tax payment due in three months. Its treasurer bids non-competitively at the next bill auction, so the order is certain to be filled at the auction yield. The cash earns a return from the government and matures just before the tax bill falls due.
Example 2
A retired shopkeeper wants somewhere safe for $20,000 of savings. She opens an account on the government's retail platform and places a non-competitive bid for a two-year note. She receives the same yield as the large institutions, without having to guess what that yield will be.
Example 3
A mortgage lender's pricing desk sees that a ten-year note auction needed a noticeably higher yield than the market expected because demand was weak. The desk widens its quoted mortgage rates by a small amount the next morning. Borrowers feel the change within days, even though they never saw the auction.
Think of it
A treasury auction is like a massive wholesale market where a government sells bulk boxes of financial produce. Buyers submit offers on how much they are willing to pay, and the government sells to the highest bidders, setting the going market price for that day.
Formula
Calculation
Discount rate = ((Face value - Price) / Face value) x (360 / Days to maturity)
Investment yield = ((Face value - Price) / Price) x (360 / Days to maturity)
Bid-to-cover ratio = Total bids received / Amount offered
To keep the arithmetic round, this example treats a bill as running for 90 days and uses a 360-day year in both measures. A company buys a bill with a face value of $10,000 at an auction price of $9,900. The discount is 10,000 - 9,900 = $100. Discount rate = (100 / 10,000) x (360 / 90) = 0.01 x 4 = 4.00%. Investment yield = (100 / 9,900) x 4 = 0.010101 x 4 = 4.04%, which is slightly higher because the return is measured against the smaller amount actually paid. If bids of $210,000,000,000 were received for an offering of $84,000,000,000, the bid-to-cover ratio = 210,000,000,000 / 84,000,000,000 = 2.5.Case study
Seen in the real world
Harborline Foods is an illustrative, fictional food distributor that borrows on a floating-rate credit line and keeps $12,000,000 of working cash. Its finance manager noticed that a series of weak auctions had pushed benchmark yields up, and that the cost of the credit line had risen with them.
She presented a short paper to the board showing that every one percentage point rise in benchmark rates added $120,000 a year to interest on the borrowed balance, while the same move raised the return on cash only slightly because the cash sat in a low-paying account. The board agreed to move $8,000,000 of surplus cash into government bills bought at auction, and to fix part of the credit line.
In the illustrative outcome, the company earned a higher return on idle cash and capped its exposure to further rises. The lesson for non-specialists is that an auction result in the news is a direct input to a company's own interest cost.
Watch out
Common mistakes
- Assuming Treasury auctions are only for banks and large funds, when individuals and small businesses can bid non-competitively and receive the auction yield.
- Treating the discount rate on a bill as the actual return, when the investment yield is higher because it is measured against the price paid rather than the face value.
- Reading a single bid-to-cover ratio in isolation, when it only means something compared with recent auctions of the same security.
Questions
People also ask
What is the difference between a competitive and a non-competitive bid?
A competitive bid names the yield the bidder will accept and may be only partly filled or missed, whereas a non-competitive bid accepts the auction yield and is filled in full.
Why does everyone pay the same price in a single-price auction?
Because the Treasury sets one clearing yield at the point where the whole offering is sold, and every accepted bid receives that yield, which encourages bidders to bid honestly.
Why should a finance team that never buys government debt care about the result?
Because the yield set at auction feeds into the pricing of corporate loans, bonds and mortgages, so it moves the company's own borrowing costs.