Auction of Treasury Bills
A treasury bill is a low risk security issued by the U.S. Government purchased for a value less than what it is worth. There is a specified maturity date in which the government pays the full price printed on the bill. The difference between the purchase price and the amount paid on the maturity date determines the discount rate. Similar to how credit card companies charge interest for borrowing their money, the buyer earns an interest dependent on both the maturity date (length of time before amount is paid) and the discount rate. The first treasury bill auction was held in 1929 and was in response to the national debt the United States accrued. After World War I, the United States accumulated a debt of $25 billion dollars, whereas before the war, the United States had only $1 billion dollars of debt. After a series of trying to improve the debt status through flawed bonds and short term debt instruments, President Hoover signed in a new security with short termed maturities purchased at a discounted face value, or a treasury bill. The government finally discovered a way to “earn cheap money to finance operations.”
Interestingly, the government performs weekly treasury bill auctions, and citizens may place either a competitive or noncompetitive bill. Noncompetitive bidders agree to accept whatever interest rate is set by the auction. This form of bidding occurs most often, as it requires no knowledge of the complex system of supply and demand. Competitive bidders submit a specified rate of interest, and determined as the average of all competitive bids. All bidders at or below the average, or set discount rate, pay this amount for the bill, including the noncompetitive bidders. All those who set their interest bid higher than the set discount rate are rejected and do not have the opportunity to purchase the bid. This auction is most similar to the Generalized Second Price Auction, except all “winners” of the auction pay the same amount in this auction. An investor can buy a maximum amount of $5 million in bids by noncompetitive bidding, and the maximum one investor can be awarded by competitive bidding is 35% of the total amount given out. This is certainly an incentive for those who choose to bid competitively, especially because these bidders tend to be experienced, knowledgeable investors. This form of investment is considered no-risk, as it is backed by the U.S. Government, but the return is often much less than other forms of investment.
References: http://money.howstuffworks.com/personal-finance/financial-planning/treasury-bills2.htm, http://www.investopedia.com/articles/bonds/10/history-t-bill-auction.asp#axzz2Ak9wQrNU
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