Last Updated on June 19, 2022 by Quantified Trading
What is an auction market? An auction market can take many forms, but in this article, we look at auctions in financial instruments, like stocks, for example.
An auction market is a platform for buyers and sellers to meet in the hope of securing favorable transactions. These transactions can occur for any type of assets such as gold, stocks, and bonds. Furthermore, auction markets are often defined by transparency and openness.
Transparency means that every participant in the market knows about the price at which an asset was sold. Access means that all the participants can place bets for an asset and the person with the highest bet wins the auction. Auction markets can be digital or physical.
Stock exchanges like the New York Stock Exchange (NYSE) is an auction market, even though much of the trading is now via electronic marketplaces.
Getting a sense of the nature of markets allows us to get into the details of the functions of markets.
What is the process of an auction market?
An auction works via the interaction of buyers and sellers. The sellers of an asset will quote the minimum price they are willing to accept and then the buyers will place their bids.
If the bids are lower than the minimum asking price, then the auction will have no transactions. On the other hand, If the bids are higher than the seller’s price, the transactions will take place. Generally, between two buyers, the highest bidder will get the asset.
Usually, in asset markets, the buyers are investors and therefore the bid price represents the investor’s expectation of returns. The more the expected returns, the higher the bids for the asset.
How does the US Treasury Department Uses an Auction Market?
The US Treasury Department System for auctioning government debt is a good real-world example of an auction market. The US government regularly faces budget deficit. Subsequently, the Treasury Department sells debt-based assets such as Treasury bills (T-Bills), bonds, and notes to finance its operations. A majority of these assets are sold via a digital auction market such as TAAPS (Treasury Automated Auction Processing System).
Types of investors in the Auction market
TAAPs allow both small and large investors to take part in this auction. Large investors (or primary dealers) include typical institutions such as banks, brokers, different types of funds, and insurance companies in addition to other players such as foreign governments and non-profit organizations. Furthermore, some designated investors are expected to bid a certain amount in every auction.
Small investors may buy these treasuries through TreasuryDirect. Buying from Treasury Direct helps small investors save on commission and brokerage fees.
Actual bidding step 1: Public Announcement
First, Every bid begins with a public announcement. This announcement is usually made several days before the auction happens. Moreover, this announcement will contain vital information related to the auction which includes the following items:
- Treasury amount to be sold
- Auction date and time
- Terms and Conditions of the auctions
- Maturity date and interest rate for the asset.
Note: Small investors can look for these announcements at the TreasuryDirect website.
In addition, T-Bills are issued on a calendar basis. The dates for different maturity T-Bills are as follows:
|Time Period||Frequency of Issuing of Bills|
|4-week bills||Weekly (Tuesdays)|
|13-week and 26-week bills||Weekly (Mondays)|
|52-week bills||Every 4 weeks (Tuesdays)|
|2-year notes||Monthly (End of month)|
|3-year notes||Monthly (Middle of month)|
|5-year notes||Monthly (End of month)|
|7-year notes||Monthly (End of month)|
|10-year notes||Monthly (Middle of month)|
|30-year bonds||Monthly (Middle of month)|
|5-year TIPS||Three times per year (Apr, Aug, Dec)|
|10-year TIPS||Bimonthly (Jan, Mar, May, Jul, Sep, Nov)|
|30-year TIPS||Three times per year (Feb, Jun, Oct)|
|2-year FRN||Monthly (End of month)|
Actual Bidding Step 2: Investing as a competitive and non-competitive bidder
Generally, after an announcement, an investor can invest as a competitive or non-competitive bidder. However, small investors always invest as non-competitive bidders. As a result, small investors cannot invest more than $5-milllion in a single auction. In addition, non-competitive bidding usually closes before competitive bidding.
A non-competitive bid means that an investor buys bonds without having to submit a price. Instead, the investor gets to pay the average price of the submitted competitive bids.
Before the closing time of the auction for competitive bids, every investor will submit the amount that they will buy and the yield (interest rate) that they will demand for that investment amount. So different investors can have the following bids:
|Bidder 1||3.15||$ 5 million|
|Bidder 2||3.25||$ 1 million|
|Bidder 3||3.5||$ 3 million|
Actual Bidding Step 3: Bid Approval by TAAPS.
Once the bids have been placed, then the online bidding software (TAAPS) will accept bids on the basis of minimizing national debt. This is done through selecting the bidders with the highest price (lowest yield demand) first and then working its way down the bidder’s list. The last yield rate on the bid that was required for all of the bonds to be sold, is the one that applies to all non-competitive bidders.
Is OTC an Auction Market?
An Over the Counter (OTC) market is different to an auction market. One of the main differences is that an OTC market often involves negotiations while auction markets have simple listings of minimum acceptable prices and bids for those assets. If the bids match, the transactions go through and otherwise there is no bargaining between the sellers and the buyers.
If you enjoyed this article you might also like our other articles answering common questions traders have!