Canadian Securities Course (CSC) Level 1 Practice Exam

Why does the government award bids from lowest yield to highest yield?

1. Due to standardized yield quotas

2. To encourage high-risk investments

3. Based on bidder preference

4. Reflecting the inverse relationship between bond yields and prices

The correct answer is: Reflecting the inverse relationship between bond yields and prices

The correct rationale behind the government's practice of awarding bids from lowest yield to highest yield relates to the inverse relationship between bond yields and prices. When the government issues bonds, they are looking to reduce the cost of borrowing. By awarding the bids starting from the lowest yield, the government secures financing at the most favorable terms available, which means paying the lowest interest rates possible. This process aligns with how bond markets operate; as yields decrease, bond prices increase. Thus, if the government selects bids based on the lowest yield first, it not only minimizes the interest expense but also reflects the market dynamics where lower yields indicate higher demand for bonds, leading to higher prices. This method is beneficial for the government since it helps in managing the overall borrowing costs effectively. The other options do not accurately capture this financial mechanism. Standardized yield quotas, high-risk investment encouragement, and bidder preference do not directly explain the government’s strategy for awarding bonds. The focus on yield prioritization provides a clear financial rationale rooted in the bond market's operational principles.