Scott Nicol Andrew Burg

 Financing Government Debt  Foreign Government Borrowing  Tax Payer Receipts  Issuance of Government Debt

 Foreign Government Borrowing  Traditional Means of Financing  World War I  Major Lending Countries at War  United States Forced to Fund the War through Increased Taxes and Debt

 Tax Payer Receipts  War Revenue Act of 1917  Increased Income Tax Rate  Decreased Minimum Tax Rate Income Level

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□ Issuance of Government Debt  Fixed Price Securities Determined by Government  1914 Peace Time Debt totaled $968 Million  1919 Interest Bearing Debt Magnified to $25.2 Billion

 1920’s - Government Noticed Fixed Price Debt was consistently over-subscribed  Indicated Under-pricing of Issued Debt  Explored the British Treasury Bill Market  Important Amendments to Debt Offering System  Securities offered when needed  Auctioned to competitive bidders  First Auction was held for $100 Million in 90 day Bills on December 10 th, 1929

 Changes Since 1929  Treasury Notes and Bonds Still Offered at Fixed Prices until 1970  By 1983 Auctions were changed to reflect the yield instead of the discounted price  Most significant change came in 1992 with the introduction of the single-price format

 Finance United States Debt  Current Debt: $10,717,998,123, (2/5/09)  Goal: Finance government borrowing at the least cost  Issue securities at regular and predictable schedule  Easier for investors to predict future offerings  Factors  Deficit?, economic outlook, maturing issues  Input from primary dealers, general public

 Multiple per week  2 Types of Bids:  Non-Competitive  Smaller Firms, Individual Investors  Specify amount only  Competitive  Primary Dealers, Institutional Investors  Specify amount wanted and yield  Single Price Auction – All winning bidders get same yield  Let’s try it.

 Scenario: Treasury Auction for $30B in 5-yr notes  Bids: Non-Competitive: 1) $1.0B Competitive: 2) $4.5B1.69% 3) $7.3B1.70% 4) $6.5B1.72% 5) $8.7B1.74% 6) $3.8B1.75% $2.0B1.75% 7) $5.2B1.76% - Total so far: $28B $2.0B remaining to auction - Pro rata share = $2.0B/$3.8B = 52.6% Stop Yield Total: $30B ………… Price too low—Receive zero

 How can they make sense? (Remember primary goal)  Fundamentally Different than regular auction  Many items, many bidders, many winners  Multiple Price (Traditional) Auctions  Winner’s Curse – causes bidders to bid lower amounts (more cautious)  Single Price Auctions  Fear of winner’s curse eliminated  Bidders bid full reservation price  Less complex = more participation = Demand Higher Price

 History of Debt Financing and the Beginning of Auctions  Goal of US Treasury: Finance public debt at least possible cost  Done by auctioning government securities in single price auctions  Single price auctions get Treasury best price for securities