THE TYPICAL BOND AUCTION PROCESS

Like with any auction, the bond auction process consists of an issuer (usually a government) which seeks to sell a certain amount of bonds in order to raise finance. Buyers (usually major financial institutions such as investment banks and pension funds) then place bids for these bonds, and the bonds are allocated according to whether the issuer accepts or rejects the bids it receives.

This process, while simple, therefore provides key information as to the supply and demand of bonds, of which 3 are the most important:

Bid-Cover Ratio

The Bid-Cover Ratio represents the ratio between the value of bonds sold and the value of bonds bid for.

Example: Germany offers to sell €9bn of a new bond at auction, and receives total bids equal to €18bn. However, Germany accepts only €8bn of these bids. Therefore, the bid-cover ratio is 18Bn / 8 Bn = 2.3 (since these are typically reported to one decimal place).

Real Bid-Cover Ratio

The Bid-Cover Ratio represents the ratio between the value of bonds initially offered and the value of bonds bid for.

Example: Germany offers to sell €9bn of a new bond at auction, and receives total bids equal to €18bn. However, Germany accepts only €8bn of these bids. Therefore, the real bid-cover ratio is 18Bn / 9 Bn = 2.

In practice, this is a much better measure of investor sentiment since buyers do not know what volume of bonds will be sold relative to the quantity of bonds initially offered.

“Stops” and “Tails”

In the context of an auction, a ‘stop’ is the lowest accepted bid price, while the ‘tail’ is the difference between the average price and the stop price.

While bid-covers provide information about the currency value of bids entered during the auction process, they do not indicate the prices at which those bids were made. Clearly, many bids for a certain issue of bond is irrelevant if those bids were made at very low prices.

Therefore, stops and tail provide an accurate gauge of how well the auction went by suggesting a lower bond for what bidders considered to be ‘fair value’. So, for example, a short tail (with the lowest bid being close to the average bid) would be positive, while a long tail (where the lowest bid was far below from the average bid) would be negative.