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How are interest rates set on US treasuries at auction

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Posted by mpstrunk
Posted on 09/18/2017 10:18 PM
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There are two markets for government securities: the primary market and secondary market. The primary market is the place where the government sells debt to a select group of financial institutions who are registered dealers. Deals must bid at every treasury auction. The secondary market is where ordinary people and institutions trade the previously issued securities in the primary market. Secondary market trading has no impact at all on the volume of financial assets in the system – it just shuffles the wealth between wealth-holders.

Before an auction the government determines the type of debt instrument to be issued, (e.g. bond, bill, note), which determines the maturity and the coupon rate, and the volume to be sold. The issue is then put out for tender and demand relative to the fixed supply in the market determines the final price of the bonds issued.

Let’s say the government wants to issue a 41,000 bond at a coupon rate of 5%. The dealers might want a 6% rate to accommodate the risk they expect to take. If so, they would bid a price lower than $1,000 to get the 6% return they seek.

When interest rates fall, the price of older bonds fall because they are less attractive versus new bonds, and visa versa. The government receives a tender on new bond issues from the bond market traders which are ranked in terms of price (and implied yields desired) and a quantity requested in millions of dollars. The government then issues the bonds in highest price bid order until it raises the revenue it seeks. So the first bidder with the highest price (lowest yield) gets what they want (as long as it doesn’t exhaust the whole tender, which is not likely). Then the second bidder (higher yield) and so on. In this way, if demand for the tender is low, the final yields will be higher and vice versa.

In reality, the Federal Reserve can control the interest rates at whatever level it wants and it did so during Work War II.

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Posted by John M. Wilkins
Answered on 09/19/2017 11:26 AM
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    I believe ordinary people can also obtain treasuries in the primary market through treasurydirect.gov. The process is different from that of the big financial institutions, but the channel is there.

    Not to be pedantic, just as an FYi to those who might be interested.

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    Posted by Ryan Taylor
    Answered on 09/20/2017 2:07 PM
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      10 year treasury bonds yields are currently 2.27%.

      So how is that figure calculated.

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      Posted by Dinero
      Answered on 09/21/2017 7:06 AM
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        Cullen Roche Posted by Cullen Roche
        Answered on 09/25/2017 7:06 PM
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