How Treasury Bill Auctions Work

Reader Dan pointed out an interesting (well, kind of) research article [pdf] that, amongst other things, explains how Treasury auctions work. As stated on the Treasury Direct site, you can buy T-Bills through either a competitive or non-competitive bid. On the surface, it would seem that you would want to put in a competitive bid to get the best price. But it’s a little fuzzier than that. If you put in a noncompetitive bid, you are just about guaranteed a bill to buy. Everyone else put in a bid for what they are willing to pay, but may not get it.

After reading the article, I put together a little example on how the bidding process works. As usual, please point out my blunders.

Let’s say you have 5 identical cars you want to sell in the same format. You get two non-competitive bidders, who have agreed to pay whatever the market decides. You then go to auction, and you get bids for $5000, $4000, $4500, $3500, and $4700. 2 cars are already set aside for the noncompetitive biiders, so then you look at the highest bidders for the remaining 3 cars – $5000, $4700, and $4500. The lowest price by a valid bidder is $4500, called the ‘stop’ price. Thus those 3 bidders and the 2 noncompetitive bidders all pay $4500 for their car. The people who bid $3500 and $4000 are rejected, which may be fine since they indicated they were not willing to pay $4500. Hope that made sense.

Most individual investors tend to bid noncompetitively. Conversely, most institutional investors bid competitively, as they are much more familiar with the process, and may need to exceed the maximum non-competitive bid amount of $5 million.

I’m satisfied with this setup, as a small time individual investor. However, if you do want to place a competitive bid you just have to find an appropriate bank, broker, or dealer. I checked with my Fidelity brokerage account, and I can bid on 3-month and 6-month T-Bills for free online, but I can’t find any 4-week bills to bid on. Not sure why. And I can’t bid at all with my I-Zone account.

The rest of the reserach article seems to go on about possible bidding inefficiencies due to how they round off the prices, which no longer exist due to added precision to the pricing of the securities.