Single-price auction

Single-price auctions are a pricing method in securities auctions that give all purchasers of an issue the same purchase price. They can be perceived as modified Dutch auctions. This method has been used since 1992 when it debuted as an experiment of the U.S. Treasury for all auctions of 2-year and 5-year notes. There is only one main difference between the multiple-price system and the single-price system. In the multiple-price format, the ranking of the desired yield and the amount stated by the competitive bidders is from the lowest to the highest yield and the amounts awarded are at the individual yields submitted by the participants. In the single-price format, all bids accepted by the Treasury are awarded at the same interest rate which is the highest yield of accepted competitive bids.[1]

History

The format of selling U.S. Treasuries by auctions was adopted in 1929 and it has evolved since then. In the beginning of the 1970s, in addition of the multiple-price auctions, were introduced auctions of coupon-bearing securities. Even before 1992, many economists and researchers had proposed the single-price system. One of them is Milton Friedman according to whom the multiple-price auction had 2 main deficiencies:

If a bidder pays more than the stop-out price, he/she is penalized even though his willingness to pay might be higher. This restriction led to pre-discussions between the other auction participants in order to assess the probable bids. Accordingly, the submission of bids resulted in a shift downwards from the "true" market demand curve.
Restricted number of participants coming from the "close to the market" rule which led to unnecessary high underwriting spread for the Treasury.[2]

The change from multiple-price auctions to single-price auctions was promoted mainly by the Treasury's interest in stimulating the competitive bidding and liquid secondary markets.[3]

U.S. Treasury Auctions

United States Treasury security auctions are conducted using the single-price auction method. In a single-price auction, all successful competitive bidders and all noncompetitive bidders are awarded securities at the price equivalent to the highest rate or yield of accepted competitive tenders. These securities include:

Treasury Auction process

The Treasury auctions have 2 main features that explain how they work:

Non-competitive bids vs. competitive bids

Non-competitive bids are the ones submitted by individuals and smaller institutions to purchase debt issues (governmental securities) on the primary market. Non-competitive bidders are guaranteed to win the auction i.e. to receive securities, but there is no guarantee on the price or yield received. They leave the auction in any cases with the amount they requested. However, they have a limit on the amount they can purchase in the framework of one auction. The maximum amount is $5 million per auction and the minimum vary depending on the type of Treasuries. For example, the minimum for a Treasury Bill is $10,000.[4] Competitive bids can be submitted only by larger financial institutions (e.g. institutional investors) because there is a condition of minimum $5 million worth. In addition, the bidders are limited to 35% of the amount of offering per auction.[5] Each participant has the right to submit one or more competitive bids, as they have to specify a minimum yield at which the bidder is prepared to buy a specified quantity of notes or the lowest discount rate at which the bidder is ready to buy a certain amount of bills. Non-competitive bids are usually opened until 12:00 (ET) while competitive ones – until 13:00.

Single-price system

All securities have the same interest rate which is determined by the lowest accepted competitive bid. And the way the interest rate is conducted is by the single-price system. After the Treasury closes the bids, the quantity of non-competitive bids is subtracted from the whole amount of securities offered and then, it starts accepting the competitive bids until the amount of securities offered is exhausted.

Example

The Treasury declares it will auction off $24 billion in securities of 2-year notes. First, we have to take into account the non-competitive bids – which in this case are $2 billion. We know that all of the non-competitive bidders get what they are asking for. Therefore, the amount of securities left for the competitive bids is $22 billion worth. The competitive participants declare the lowest interest rate they are willing to receive and the amount of Treasuries they want:

Company 1: bids $7 billion with interest rate of 2.70 = $7 billion awarded
Company 2: bids $5 billion with interest rate of 2.75 = $5 billion awarded
Company 3: bids $6 billion with interest rate of 2.80 = $6 billion awarded
Company 4: bids $8 billion with interest rate of 2.85 = $4 billion awarded
Company 5: bids $6 billion with interest rate of 2.85 = $0 billion awarded

Outcome: Since there are $22 billion of Treasuries, the bid of company 1 is accepted at their interest rate of 2.70, then the bids of company 2 and 3 are also accepted. Until we get to company 4 when there are only $4 billion of securities left - only $4 billion awarded instead of the $8 billion asked. There is nothing left for company 5. Since the last company to receive any securities is company 4 - the interest rate they declared, becomes the standard one for all Treasuries. Then, company 1,2,3 also obtain 2.85% as interest rate, as well as the non-competitive bidders.

References

Archibald, Christine M.; Malvey, Paul F. (October 1998). "Uniform-Price Auctions: Update of the Treasury Experience" (PDF). Office of Market Finance U.S. Treasury Washington, D.C: 4.
Goldstein, Henry (August 1962). "The Friedman Proposal for Auctioning Treasury Bills". Journal of Political Economy. 70 (4): 387. doi:10.1086/258666. JSTOR 1861735. S2CID 155071267.
Garbade, Kenneth D.; Ingber, Jeffrey F. (February 2005). "The Treasury Auction Process: Objectives, Structure, and Recent Adaptations" (PDF). Current Issues in Economics and Finance. 11 (2): 3.
Chen, James. "Non-Competitive Tender". Investopedia. Retrieved 26 April 2019.
Chen, James. "Non-Competitive Tender". Investopedia. Retrieved 26 April 2019.

Individual - Auction FAQs (www.TreasuryDirect.gov)

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[1] Archibald, Christine M.; Malvey, Paul F. (October 1998). "Uniform-Price Auctions: Update of the Treasury Experience" (PDF). Office of Market Finance U.S. Treasury Washington, D.C: 4.

[2] Goldstein, Henry (August 1962). "The Friedman Proposal for Auctioning Treasury Bills". Journal of Political Economy. 70 (4): 387. doi:10.1086/258666. JSTOR 1861735. S2CID 155071267.

[3] Garbade, Kenneth D.; Ingber, Jeffrey F. (February 2005). "The Treasury Auction Process: Objectives, Structure, and Recent Adaptations" (PDF). Current Issues in Economics and Finance. 11 (2): 3.

[4] Chen, James. "Non-Competitive Tender". Investopedia. Retrieved 26 April 2019.

[5] Chen, James. "Non-Competitive Tender". Investopedia. Retrieved 26 April 2019.