Treasury Auctions and the Secondary Treasury Market 4/27/ Zeno Helm: BA 543

Treasury Auctions: A Brief History  Treasury issuance of war bonds began as an effort to cover anticipated WWI debt 1917  No outside countries available to borrow from so the debt had to be financed internally  Rate and maturity fixed by the government  After the war more bonds were issued to cover those now reaching maturity  Again government price fixed  Oversubscription showed government was overpaying for or undervaluing its debt  Auctions were then implemented (1929) to allow for the market to determine the true value of the issued securities 4/27/2011 Zeno Helm: BA 543 2

What’s the Prize?Why Auction? 4/27/2011 Zeno Helm: BA Treasury Auctions: The Basics  Treasury Securities  Most liquid (readily tradable)  Highest volume of debt in the world  Continually supported by the issuance of new securities  Allows for market demand to set the yield.  Auctions reveal market interest indicated by the “bid-to-cover” ratio.  Treasury department controls timing and quantity of new issues

4/27/2011 Zeno Helm: BA Types of Securities Treasury Bills Discount Security Maturity: 1 Year or Less Treasury Notes Coupon Security Maturity: 2-10 Years Treasury Bonds Coupon Security Maturity: Longer than 10 Years

Auction Cycles: What and When  Treasury Bill Auctions (Discount)  3 and 6-month bills every week  1-year bills every 4 weeks  Treasury Note Auctions (Coupon)  2 and 5-year notes monthly  10-year notes quarterly  Treasury Bond Auctions  30-year bonds quarterly  Reopened Issues  Increasing amounts of outstanding issues 4/27/2011 Zeno Helm: BA 543 5

The Auction Process Declaration of Auction Treasury Offering Term and Amount Reported Date of auction and bid submissions declared Submission of Bids Primary Dealers Certified by the US Treasury Begin as a reporting dealer Awarding of Securities Auction Ends and Stop Yield is Reached Bids arranged from lowest to highest yield or highest to lowest price All bidders below stop yield receive the same yield rate bidders at SY are prorated with remaining securities 4/27/2011 Zeno Helm: BA 543 6

The Auction Process 4/27/2011 Zeno Helm: BA Bid below the “stop yield” Regardless of yield bid all winners receive the SY rate Competitive Limited amount of securities allotted for non- competitive bids Have no say in the SY value Noncompetitive Bid above the SY and “shut out” Bids recorded for the bid-to-cover ratio Losers

Secondary Treasury Market 4/27/2011 Zeno Helm: BA 543 8

Secondary Market: Repos  “Repurchase agreements” for treasury securities  Helps the Federal Reserve control short term interest rates  Helps dealers of securities manage liquidity  Like a loan, however the ownership of the security actually changes hands from buyer to seller 4/27/2011 Zeno Helm: BA Dealer Borrows Cash Seller Receives Security as Collateral Dealer Buys Back the Security Repo: Reverse Repo:

Repo Terminology  Term Repo vs. Overnight Repo  Reversing In vs. Reversing Out Securities  Selling Collateral vs. Buying Collateral  Repo Rate: Short term loan interest (cost of financing) Government Repo  System and Customer Repo NOT Buying Collateral  Matched Sale NOT Selling Collateral 4/27/2011 Zeno Helm: BA

Questions….. And Maybe Answers 4/27/2011 Zeno Helm: BA

Works Consulted  Wikipedia…. Duh  Yahoo Finance  Foundations of Financial Markets and Institutions – Fabozzi, Modigliani, and Jones  Three OSU Finance Professors: to be specifically named based on the quality of the preceding presentation 4/27/2011 Zeno Helm: BA