AUCTION MECHANISM
Types of Auctions
i. Yield Based Auction is used for Government securities issued for the first time. Bids are
submitted for deciding the coupon rate which is the cut off yield decided in auction based on the
tenure. Successful bidders are those who have bid at the cut-off yield or lower, bids above the
cut-off yield are rejected.
ii.Price Based Auction is used when RBI re-issues G secs already existing in the market.
Bidders quote the price per Rs 100 face value of the G-sec. Successful bidders are those who
have bid at the cut-off price or higher, bids below the cut-off price are rejected.
5.1.Issue of Securities through auction
(i) The Securities will be issued through auction either on price basis or on yield basis.
Where the issue is on price basis, the coupon will be pre-determined and the bidders have to
quote the price per Rs.100.00 face value of the security, at which they desire to purchase the
security. Where the issue is on yield basis, the coupon of the security is decided in an
auction conducted by Reserve Bank of India in the manner hereinafter as provided and further
provided by the Specific Notifications issued from time to time. The security carries the same
coupon till maturity.
On-tap issue
This is a reissue of existing Government securities having pre-determined yields/prices by
Reserve Bank of India. After the initial primary auction of a security, the issue remains open to
further subscription by the investors as and when considered appropriate by RBI. The period for
which the issue is kept open may be time specific or volume specific. The coupon rate, the
interest dates and the date of maturity remain the same as determined in the initial
primary auction. Reserve Bank of India may sell government securities through on tap issue at
lower or higher prices than the prevailing market prices. Such an action on the part of the
Reserve Bank of India leads to a realignment of the market prices of government securities.
INFLATION INDEXED BONDS
While the nominal yield of a bond can be adjusted to account for expected inflation at the time
the bond is issued, the bond's actual real yield varies with actual inflation, which can be quite
different from what was expected. If actual inflation rises unexpectedly, the real rate falls; and if
inflation declines unexpectedly, the real rate increases. Because it is impossible to know with
certainty the actual rate of future inflation, inflation risk is intrinsic to nominal bonds and cannot
be eliminated.
While a nominal bond's cash flow and nominal yield are adjusted by expected inflation when the
bond is issued, the coupon payments and maturity value of a real bond are adjusted over the
entire life of the bond.
Limitations due to the choice of the inflation index
The choices include the implicit and fixed-weight GDP price deflators, the producer price index
(PPI), the consumer price index (CPI), and the consumer price index excluding food and energy
(the core CPI). Each of these indexes provides a different measure of inflation because of
differences in the baskets of goods whose prices are being measured and in the weights used to
average the prices.
Limitations caused by the lag of indexation. Lags in indexation are necessary because the value
of an index is known only with a lag. The lag in indexation makes it more difficult to extract
near-term information on real interest rates and inflation expectations.
MARKET LIQUIDITY
While the likely tax treatment for indexed bonds could limit the liquidity of the market,
experience abroad suggests the indexed bond market would be less liquid than the nominal bond
market even without the tax effect. In the United Kingdom, for example, the nominal increase in
the principal of an indexed bond is not taxed. Nevertheless, indexed UK government bonds are
less liquid than nominal bonds--indexed bonds are turned over only about one-third as often as
nominal bonds.
With the tax effect, it is even more likely that the U.S. market for indexed Treasury bonds would
be less liquid than the market for nominal Treasury bonds.
