Finance

< WSJ “Auction Results” >

U.S. Government is selling $1,000,000 bills to be delivered in 26 weeks.  Bid prices that the buyer is willing to pay today for this promise are collected at regular intervals, and short-term risk free rates are set using these prices.

Question: What is the rate of return if the 26 week Bill is purchased at the “Auction Price” and held for 26 weeks until the $1,000,000 bill is delivered?

-They want people to offer a lot for that $1M. The rates will be low if bids are high. They accepted the people who were willing to pay the most. People who didn’t get to participate wanted a higher rate of return.

-People think about what they can earn risk free.

-TVM setup

Future Value = 1,000,000

Present Value = 999,772.50

FV/(1+i/m)^n = PV

M=2

N=# yrs * m

=1/2 * 2

N=1

1,000,000/(1+i/2)^1=999,772.50

i=.00046

i=.046%

**this is also the coupon equivalent (.046%)

-spread – value that compensates for defaulters

-lend to private entity if you earn more and it covers more than just the defaults, lender has to be better off after defaults than lending to US gov (credit spread starts at .5% if you are AA

-private firm needs to offer something very competitive because the risk is higher

-Ask there are richer opportunities, gov’t will need to pay more for money and if gov’t has to pay more than firms will have to pay more (credit spread is in addition to the US borrowing rate)

-the gov’t takes the bids based off on the amount they want to borrow to people

Auction Graph in Supply and Demand Curves

Auction process:

1. Bids solicited
2. Bids are sorted high-to-low price
3. Government decides how much money it wants to raise from auction.
4. Government starts by accepting the highest priced bid and then begins accepting lower and lower bid prices until it has raised enough funds.   The more funds the government wants to raise, the lower the bids it must accept to do so.  The bid price is determined as the price at which it has sufficient bids to raise the quantity of funds it wants.

Question: Did all the bids get filled?

Question:  Say there exists a nation that exports a great deal of product to the U.S., and so collects lots of dollars.  Does this make it easier or more difficult to sell T-bills?