In an auction for treasury securities, the government is the issuer, seeking to borrow money, while Primary Dealers (PDs) are the investors bidding to purchase these securities. The government’s goal is to minimize its borrowing cost, meaning it prefers bids with lower yields (interest rates). Here is how the process works:
For example, the government intends to raise BDT 100 Cr. in this auction. The following bids have been submitted by PDs:
The government starts by accepting the lowest yield bids and moves upward, accepting higher-yield bids as needed. Here’s the breakdown:
Lowest Yield Bids Accepted First
The government first accepts 15 billion from Sonali Bank PLC at 8.3%, then 10 billion from Janata Bank PLC at 8.8%, and so on.
Funds Raised at the Cut-Off Yield
By the time the government accepted 15 billion from Uttara Bank PLC at 10.0%, it had raised a total of 60 billion.
Development Liability
The government stops accepting bids beyond 10.0%, leaving 40 billion of its funding target unmet. This remaining amount is distributed as a development liability among PDs, meaning they are required to purchase treasury securities at the 10.0% yield, even if they initially bid at a higher rate.
Why Does the Cut-Off Yield Matter?
The cut-off yield balances the government’s borrowing cost and the market’s willingness to lend. PDs bidding above the cut-off yield receive no allocation unless they are assigned a development liability, while those bidding at or below it secure their desired allocation.