A few days before the actual auction happens, the Treasury Department publishes an official auction announcement on their website. The announcement lists the key terms for the bond that will be auctioned. You should read the announcement before you decide to buy from the auction.
1. Estimate the Yield. You will not know what the yield will be until the auction is over, but you can take a guess using the current yield on existing bonds which are traded on the secondary market. I use the Daily Treasury Real Yield Curve Rates published by the Treasury Department and the yield charts by Federal Reserve Bank of St. Louis: 5-year, 10-year, and 20-year. Here's what the chart for the 10-Year TIPS looked like in July 2008:
The yield from the auction should be close to the yields on similar bonds on the market, give or take daily market fluctuations. Remember the number is the real yield, which is above and beyond the reported inflation number. You have to decide yourself whether it is a good yield for you or not. Typically if the yield is above 3%, it's considered a good yield. If it's below 1%, it's not so good.
Sometimes the yields on TIPS of different maturities are close to each other ("flat yield curve"). Sometimes there is a large difference ("steep yield curve"). As you can see from the chart below, the 10-year (blue line) was close to the 20-year (red line) in 2006 and most part of 2007. A large gap developed in 2008.
If you are interested in buying the TIPS to be auctioned and you'd like to get a handle on how much money you will need, you will need some data from the announcement to do the calculation.
2. New Issue vs. Reopening. Sometimes the auction is a new issue. Sometimes it's a reopening. A new issue means the bond is brand new, never been sold before. Its stated interest rate or the "coupon" rate will be determined by the auction. The coupon rate will be set to the nearest 0.125% below the high yield in the auction. The purchase price will be adjusted accordingly. For example if the yield from the auction is 1.485%, the coupon will be rounded down to 1.375%. A reopening means the Treasury Department will sell additional quantities of an existing bond they sold before. The coupon rate on a reopened bond is already known. The auction will determine only the yield and price. If the auction is for a reopening, it will say so in the announcement.
Another difference between a new issue and a reopening is the inflation adjustment. Because a reopened bond has been on the market for three to six months, it has accumulated some inflation adjustment. A reopened bond typically costs slightly more in nominal dollars than a new issue unless its coupon rate is significantly below the current market yield.
This partial screenshot taken from the announcement show the auction is for a new issue because the interest rate is determined at auction. If it were a reopening, the interest rate would be listed.
3. Important Dates and Index Ratio. The announcement contains many data points but only these are relevant for estimating how much a bond will cost.
- Issue Date: the date you will officially own the bond
- Maturity Date: the date they will pay you back
- Dated Date: the date from which the interest will be calculated
- Interest Rate (reopening only, not applicable to new issues): the coupon rate
- Index Ratio: the Consumer Price Index value on the Dated Date divided by the Consumer Price Index value on the Issue Date
4. Estimate Dollars Needed. Plug in the data you gathered from above together with your yield estimate into my TIPS pricing spreadsheet. You will see roughly how much you will need for each bond.
Next step: place order if you are going to buy it.