A bill auction is like a big sale that happens every week or month. It’s organized by the Government Treasury, which is the government’s money department. In this auction, the government sells off Treasury bills, also known as T-bills. These bills are like IOUs from the government and they last from one month to one year.
Like in the USA as of May 2021, 24 special dealers must join the auction and make bids directly to buy these bills. The auction is the official way that the government releases all its Treasury bills. While in Kenya you can buy even from M-Pesa.
Understanding a Bill Auction
The weekly bill auction is like a big sale that happens online. Investors who want to buy government bills bid on how much they want and how much they’re willing to pay. The best bid wins. But unlike a regular auction where prices go up, here the price is set after everyone has made their bids.
Before the auction, there’s an announcement telling everyone when it will happen, how much will be sold, when the bidding closes, and who can participate. Bids can be made up to 30 days before the auction.
During the auction, investors compete to get the best deal on the bills. A special group of banks and brokerages, called primary dealers, have to bid on a share of every auction. The winning bid sets the interest rate for that bill. Once they buy bills, the dealers can keep them, sell them, or trade them. How many bills are sold depends on what’s happening in the market and the economy.
Who Participates in a Bill Auction?
In a Treasury auction, people who want to buy government bills are divided into two groups: retail investors and institutional investors. They can make two types of bids: competitive and non-competitive bids.
Non-competitive bids are from smaller investors. They don’t know the final price or discount rate until the auction ends, but they’re guaranteed to get bills.
Competitive bids are from bigger investors, like institutions. Each bidder can ask for up to 35% of the bills offered. They specify the lowest rate they’re willing to accept. The bids with the lowest rates are accepted first. The final accepted rate is the lowest one that matches the amount of debt being sold.
Unlike non-competitive bidders, competitive bidders aren’t guaranteed to get bills. If their offered rate is too low, they might not get anything. But those who bid at or above the winning rate get bills at that rate.
How a Bid Auction Works
Let’s say the government wants to sell $9 million worth of one-year T-bills. They set a 5% discount rate. You can’t buy a bill for less than $100, but most bills sold are between $1,000 and $10,000 each.
Here are some bids people submit:
- $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 government will accept bids with the lowest discount rates first because they want to pay less to investors. They need $9 million, so they’ll take bids with rates up to 5.07%. For example, they’ll accept $2 million of the $3 million bid at 5.07%. They’ll take all bids below 5.07% and reject those above it. The auction settles at 5.07%, and successful bidders get that rate.
On the day the bills are issued, the government gives T-bills to bidders who made non-competitive bids in the auction. They charge the bidders’ accounts for the payment of the bills. The price of the T-bill is shown as a price per hundred dollars.