Academic journal article Journal of Money, Credit & Banking

Does Urgency Affect Price at Market? an Analysis of U.S. Treasury Short-Term Finance

Academic journal article Journal of Money, Credit & Banking

Does Urgency Affect Price at Market? an Analysis of U.S. Treasury Short-Term Finance

Article excerpt

THIS PAPER CONSIDERS whether timeliness of requests, that is to say "urgency," impacts terms for borrowers. Specifically, it considers the market for unscheduled issuance of U.S. Treasury debt in the form of Cash Management Bills (CMBs) and compares it to the traditional market for anticipated bills. The paper finds evidence of a significant increase in yield associated with unscheduled issuance. The paper then considers key aspects of the CMB market to see if there are ways to reduce issuance costs. Factors are found which can improve terms of finance for unscheduled debt issued by government, and by extension for borrowers generally.

Traditionally, businesses have had to consider the risk of returning to financial markets ahead of expectations when financing operations. History is rife with examples of investors demanding greater returns in later rounds of finance, when a firm's return to market signals an increase in risk to financiers. A couple of famous examples from recent history might be the financing of the tunnel between France and the UK (Fetherston 1997), and the difficulties faced by investor owned utilities in California to finance continuing operations during the second half of the year 2000, following substantial changes in the state's regulation of electricity (Taub 2000; (1) Press releases by Pacific Gas & Electric: 4/6/2001, Southern California Edison: 11/ 17/2000, and San Diego Gas and Electric 2/6/2001, as cited by U.S. Energy Information Agency 2002).

However, increases in risk may not be the only reason that particular entities are charged above market rates for unexpected and urgent issuance. To sort out whether or not inelastic demand can account for a premium, abstracting from increased risk, we would ideally observe an entity which returns to market unexpectedly and urgently without signaling any change in its risk profile. Because of a long earned reputation for orderly repayment and responsible dealing with markets, the U.S. Treasury is this ideal entity.

The United States schedules regular debt issuance with a variety of maturities as a means of managing exposure to credit markets while satisfying investor desires for products that differ in terms of maturity, but not in terms of quality. In addition the Treasury manages cash balances as a function of expected revenue and obligations so as to minimize the stock of excess cash on hand. From time to time, as a function of circumstance, the U.S. Treasury finds cash balances to be less than desirable. The Treasury then issues debt in the form of a Cash Management Bill to meet anticipated cash inventory shortfalls.

Treasury Bills are typically denoted by their date of maturity, and are regularly reopened. A reopening expands an offering some time after the original auction and adds to the amount coming due at maturity. For example, a 52-week bill may be reopened as a 26- or 13-week bill that matures on the same date as the original issue. While typically purchasers expect a reopening, a Cash Management Bill reopening is less expected before announcement. (2) In addition, purchasers must quickly respond to the CMB announcement. Taken alone, these conditions, might lead CMB purchasers to require a greater yield. However, a CMB typically adds significant liquidity to an outstanding issue, and in general purchasers value liquidity because increased liquidity creates a larger and more continuous market for trade in an instrument. Given these two competing conditions it is unclear, a priori, what yield must be borne by a trusted borrower who expands liquidity with an unscheduled issue.

To attempt to assess the cost of urgency for the case of U.S. Treasury cash management one must first put yields in context. This work will construct a measured average differential between the Cash Management Bill and the nearest two maturing bills: a bill maturing just before, and a bill maturing just after the CMB. While bills typically mature seven days apart from one another, this is not always the case, thus a minor innovation will re-weight the average to account for relative maturity of the CMB. …

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