Methods of Issuance of Government Securities

Government securities are issued by various methods, which are as follows:

Auctions for government securities are either yield based or price based.

Yield Based Auction:
A yield based auction is generally conducted when a new Government security is issued. Investors bid in yield terms up to two decimal places (for example, 8.19 per cent, 8.20 per cent, etc.). Bids are arranged in ascending order and the cut-off yield is arrived at the yield corresponding to the notified amount of the auction. The cut-off yield is taken as the coupon rate for the security. Successful bidders are those who have bid at or below the cut-off yield. Bids which are higher than the cut-off yield are rejected.
Price Based Auction:
A price based auction is conducted when Government of India re-issues securities issued earlier. Bidders quote in terms of price per Rs.100 of face value of the security (e.g., Rs.102.00, Rs.101.00, Rs.100.00, Rs.99.00, etc., per Rs.100/-). Bids are arranged in descending order and the successful bidders are those who have bid at or above the cut-off price.

The basic features of the auctions are given below:

Method of auction: There are two methods of auction which are followed-

In a Uniform Price auction, all the successful bidders are required to pay for the allotted quantity of securities at the same rate, i.e., at the auction cut-off rate, irrespective of the rate quoted by them. On the other hand, in a Multiple Price auction, the successful bidders are required to pay for the allotted quantity of securities at the respective price / yield at which they have bid.

Bids: Bids are to be submitted in terms of yields to maturity/prices as announced at the time of auction.
Cut off yield: is the rate at which bids are accepted. Bids at yields higher than the cut-off yield is rejected and those lower than the cut-off are accepted. The cut-off yield is set as the coupon rate for the security. Bidders who have bid at lower than the cut-off yield pay a premium on the security, since the auction is a multiple price auction.
Cut off price: It is the minimum price accepted for the security. Bids at prices lower than the cut-off are rejected and at higher than the cut-off are accepted. Coupon rate for the security remains unchanged. Bidders who have bid at higher than the cut-off price pay a premium on the security, thereby getting a lower yield. Price based auctions lead to finer price discovery than yield based auctions.
Notified amount: The amount of security to be issued is ‘notified’ prior to the auction date, for information of the public.
The Reserve Bank of India (RBI) may participate as a non-competitor in the auctions. The unsubscribed portion devolves on the Primary Dealers if the auction has been underwritten by PDs. The devolvement is at the cut-off price/yield.

Underwriting in Auctions

For the purpose of auctions, bids are invited from the Primary Dealers one day before the auction wherein they indicate the amount to be underwritten by them and the underwriting fee expected by them.

The Underwriting Commitment on Central Govt. Securities are dividend into two parts – MUC (Minimum Underwriting Commitment) and ACU 9Additional Underwriting Commitment).

The auction committee of Reserve Bank of India examines the bids and based on the market conditions, takes a decision in respect of the amount to be underwritten and the fee to be paid to the underwriters.
Underwriting fee is paid at the rates bid by PDs , for the underwriting which has been accepted.
In case of the auction being fully subscribed, the underwriters do not have to subscribe to the issue necessarily unless they have bid for it.
If there is a devolvement, the successful bids put in by the Primary Dealers are set-off against the amount underwritten by them while deciding the amount of devolvement.

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. Tap stock provides an opportunity to unsuccessful bidders in auctions to acquire the security at the market determined rate.

Fixed coupon issue
Government Securities may also be issued for a notified amount at a fixed coupon. Most State Development Loans or State Government Securities are issued on this basis.

Open Market Operations (OMO)
OMOs are the market operations conducted by the Reserve Bank of India by way of sale/ purchase of Government securities to/ from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market.