Treasury Auctions and Bill Yields

Why this matters

Every yield in this track is measured against Treasuries, and the yield curve in The Yield Curve in Depth is built from the securities the Treasury auctioned most recently. So it's worth knowing how those auctions work. There's a practical reason too. Treasury bills are among the simplest things an investor can buy, and the rate they're quoted at isn't the rate they pay. This lesson covers the auction, then the arithmetic of bills, then the one Treasury security whose rate changes every week. The rules described are US rules.

What the Treasury sells

Bills, notes, and floating rate notes can each be bought for as little as $100.¹²⁴ Interest on bills and notes is subject to federal income tax, and no state or local income tax is due on it.¹²

How an auction works

The Treasury doesn't set the rate on a new security. It announces how much it will sell, and bidders decide the rate. An auction runs in four steps: the Treasury announces it, bidders submit bids, the auction is held, and the securities are issued a few days or weeks later.⁵

There are two kinds of bid.⁵

• A non-competitive bid names only an amount, up to $10 million. The bidder agrees to accept whatever rate the auction produces, and these bids are accepted first. It's the only kind of bid a TreasuryDirect account can make.
• A competitive bid names an amount and the rate the bidder is willing to accept. It has to go through a bank, broker, or dealer, and one bidder can take at most 35% of the offering.

The Treasury first accepts all the non-competitive bids. It then accepts competitive bids starting from the lowest rate and working upward until the offering is filled. The last rate accepted is the highest, and every successful bidder, competitive or not, receives that same rate.⁵ If the bids at that final rate add up to more than is left, each is filled in the same proportion.⁶

Bids	Amount bid	Amount awarded	Left to sell
Non-competitive	$2 billion	$2 billion	$48 billion
Competitive at 4.480%	$12 billion	$12 billion	$36 billion
Competitive at 4.490%	$15 billion	$15 billion	$21 billion
Competitive at 4.500%	$14 billion	$14 billion	$7 billion
Competitive at 4.510%	$20 billion	$7 billion	None
Competitive at 4.520%	$18 billion	None

The offering runs out partway through the bids at 4.510%, so that's the auction's high yield. Those bidders each receive 35% of what they asked for, since $7 billion is left for $20 billion of bids. Everyone who was awarded notes, including the bidder who would have accepted 4.480% and the individuals who bid non-competitively, gets a yield of 4.510%. The bids at 4.520% get nothing.

Paying every winner the same rate is called a single-price auction. It changes how a bidder should think. A bidder who asks for too high a rate risks missing out, and one who bids low still receives the higher rate everyone else gets, so there's less reason to shade a bid.

From yield to coupon and price

The auction produces a yield. A note or bond also needs a coupon rate, and the Treasury sets it so that the price comes out as close to face value as possible without going above it.⁶ The buyer then pays slightly less than face value, as Yield Measures would predict for a bond whose coupon is a little below its yield. The Treasury's own examples show the pattern: a 20-year bond auctioned at a high yield of 1.850% was given an interest rate of 1.750% and a price of $98.34 per $100, and a 7-year note at 1.461% was given 1.375% and a price of $99.43.³ The coupon is never set below 0.125%.³

The rest of this lesson is for members

Still to come in this lesson: Treasury bills: three rates for one security, Floating rate notes, the key takeaways, and 2 quiz questions with explanations.

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