Primary Dealer Bidding in a 5-Year PIB Auction

The client orders require a yield of at least 14.80%. If the cut-off is expected at 14.70%, a bid at 14.80% is above the cut-off and will not be accepted in a conventional yield auction, because the cut-off is the highest accepted yield and lower yields are more aggressive. You therefore cannot satisfy the clients' minimum yield and also bid at the expected clearing level. The correct response is to explain this conflict to the clients and either bid at 14.80% on a best-efforts basis, accepting that the order may receive no allotment, or execute the orders in the secondary market at 14.82%, where the yield is available. For the bank's own book, a bid at 14.70% is consistent with the research view, but it offers no margin for error. A more disciplined bid would be 14.68–14.70%, sized modestly, with additional bids at 14.60% only if the desk wants a higher probability of allocation. The total bid should remain within the PKR 25bn limit, including the existing inventory and settlement obligations. Because the competing dealer may bid aggressively, do not chase the cut-off downward: a bid at 14.55% may win a large allocation but at a yield that is below funding cost and below the secondary market. The auction strategy should be to bid for a limited own-book position at around 14.68–14.70% and to keep client orders separate.

If the bank is allotted at a 14.70% cut-off and funds at 6-month KIBOR of 15.30%, the immediate carry is negative by about 60 bp a year. On a PKR 5bn allocation, that is roughly PKR 30m a year before any mark-to-market gain. The expected 50 bp policy rate cut would produce a price gain approximately equal to modified duration times the yield change. For a 5-year PIB, modified duration is roughly 4.0–4.3; a 50 bp fall gives about 2.0–2.2% of price, or PKR 100–110m on PKR 5bn. That gain more than offsets one year of negative carry, so the trade is viable if the rate cut actually occurs and if the position can be held or sold into the rally. If the cut does not occur, the bank is left with negative carry and possible mark-to-market loss if yields rise. The existing PKR 12bn inventory is marked at 14.90%; if the market moves to 14.70%, the inventory gains approximately 4.0–4.3 × 20 bp ≈ 0.8–0.9%, or about PKR 96–108m, which partly offsets the lower yield on new paper. The auction allocation should therefore be sized so that the expected price gain covers the carry and a stress case. A PKR 3–5bn own-book allocation is reasonable; a PKR 20bn allocation at a sub-15.30% yield is not, unless the desk has a firm view and a hedge.

A non-competitive bid is useful when the investor wants certainty of allotment at the auction cut-off without taking cut-off risk. It avoids the winner's curse: a competitive bidder who wins at an aggressive yield may discover that the cut-off was even lower and that the paper is worth less than the bid price. Non-competitive bids are, however, subject to the auction rules and any limits, and they do not allow the dealer to influence the cut-off. For the pension fund clients, a secondary-market purchase at 14.82% is preferable to a competitive bid at 14.80% because it is executable now, avoids auction uncertainty and gives a slightly higher yield. The execution plan should be: (1) confirm client orders as secondary-market orders at 14.82% or as non-competitive bids if eligible; (2) submit a limited own-book competitive bid at 14.68–14.70%, not above; (3) keep total bids within the PKR 25bn limit and within the 5-year line concentration limit; (4) monitor the when-issued and secondary market into the auction; (5) if the cut-off comes above 14.70%, treat the result as a signal that the market does not share the research view and reduce exposure; (6) if the cut-off comes at 14.60% or lower, do not chase the next auction without reassessing funding cost. The key discipline is to separate client facilitation from proprietary risk and not to let a competitor's aggressive bidding set your bank's risk appetite.