Friday, February 23, 2007
A when-issued market B. Venkatesh IN THE recent Credit Policy, the RBI Governor suggested that the central bank might introduce a "when-issued" market in consultation with the government. What is a when-issued market? Suppose the RBI is planning to sell 10-year government bonds. A when-issued market is one where trading takes place in that bond before the issuer sells the securities in the primary market. A when-issued market is very active in government bonds in the US. Why have a when-issued market? Government bonds are typically sold through auctions conducted by the RBI. This is not like the book-building process that we have for stocks. In a book-building process, you are aware of the bids at various price levels. This helps you decide whether to apply for the shares at a particular price. Bond auctions are, however, not transparent. That is, one bond investor does not know the price at which the other is bidding. This leads to a condition called a winner's curse. If an investor quotes a high price, she may be allotted the bonds bid for. But what if the bonds trade at a lower price in the secondary market? The investor actually losses though she was successful at the auction. So, what do the buyers at the auction do? They do not quote a high price lest they should suffer from winner's curse. But, that is bad for the government! If the buyers do not quote a high price, the government's borrowing cost will increase. A when-issued market helps in this regard, as the RBI (the auctioneer) gets an idea of what the market is willing to pay for the bonds. And that helps the central bank set an optimal price for the issue.