U.S. government securities are first sold to investors through Treasury auctions. You can buy new-issue Treasuries either through the government’s platform (TreasuryDirect) or through a broker-dealer. As with any auction, buyers submit bids. Two types exist:
Competitive bids are usually submitted by large financial institutions that buy significant amounts of Treasury securities for customers or for their own portfolios. These bids are “competitive” because awards go to the best offers. A competitive bidder states:
For example, a bank might bid for $5 million of Treasury bills at a yield of 4%. We’ll walk through how the bidding works next.
Non-competitive bids are usually submitted by retail investors. The maximum allowable bid is $10 million. Non-competitive bidders are guaranteed to receive the amount they bid for, and they receive the yield determined by the competitive auction.
To see the mechanics, assume the Treasury offers $50 million of Treasury bonds and receives $20 million of non-competitive bids. That leaves $30 million to be awarded to competitive bidders. These competitive bids come in:
The Treasury accepts the lowest yields first (the issuer wants to pay the lowest acceptable return). With $30 million available for competitive awards:
Because Institution #4 is the last winning bid, its yield (6.50%) becomes the yield assigned to:
In other words, the “highest of the lowest” winning yields sets the yield for the entire offering. Real auctions have additional details, but this example captures the core idea.
After the auction, U.S. government securities trade in the over-the-counter (OTC) markets. As you saw in an earlier chapter, an OTC trade doesn’t occur on a physical exchange like the New York Stock Exchange. Instead, investors buy and sell through networks of dealers, brokers, and financial institutions.
Like most securities today, Treasury securities are issued in book entry form, so there’s no physical certificate.
Like corporate bonds, U.S. government debt is typically quoted in percentage of par. The key difference is the fraction:
The Treasury market is extremely large and active, so quoting in 32nds allows for finer price differences.
Treasury quotes may look different, but converting them to a dollar price works the same way as with corporate bonds.
An investor finds three separate quotes for the same bond:
- 95-8
- 95:8
- 95.8
Treasury quotes can use a dash, colon, or period. In all cases, the number to the right is assumed to be in 32nds, so each quote means:
Unlike corporate bond quotes, you don’t reduce the fraction.
If you use the same “fraction-boot-scoot” method we used with corporate bonds, you can convert the quote to a price. The only difference is that the fraction is in 32nds.
A US Government bond is quoted at 95-8. What is its price?
Step 1: calculate the fraction
Step 2: boot the decimal back to the big number
Step 3: scoot the decimal once over to the right
Think you can do it on your own? Give it a try!
A US Government bond is quoted at 103:20. What is its price?
Step 1: calculate the fraction
Step 2: boot the decimal back to the big number
Step 3: scoot the decimal once over to the right
As you can see, the process is very similar to corporate bond quotes. The quotes look different, but both corporate and U.S. government securities are quoted in percentage of par.
Treasury bill quotes are an exception. Because T-bills are short-term, zero-coupon securities, they’re quoted in discount yield form, which reflects the rate of return the bill provides. The same idea applies to similar securities like commercial paper.
For example, a Treasury bill quote might be 3.2%. This quote is a yield, not a price. Remember:
T-bill bid-ask quotes may also look different. For example:
3.2 x 3.1
Most bid-ask quotes show the smaller number on the left (bid) and the larger number on the right (ask). T-bill bid-asks can look reversed, but the meaning is the same:
The key is that T-bills are quoted in yields, and yields move inversely to prices:
So a yield of 3.2% corresponds to a lower-priced T-bill than a yield of 3.1%. A yield of 3.1% corresponds to a higher-priced T-bill than a yield of 3.2%.
Bottom line: if a bid-ask looks “backward” (higher number on the left, lower number on the right), it’s usually because the quote is yield-based. Treasury bills are the most common example.
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