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• W2034159715 abstract "The Investment Bankers Association for many years encouraged the use of the interest cost method of computing the cost of a bond issue [e.g., 1, pp. 128-131]. This usage did not generate much excitement in the financial or academic communities until the fall of 1972. In October 1972, a $25 million pollution control bond issue of the state of Minnesota made headlines in business periodicals and the financial sections of many newspapers. The bonds were awarded to Dillon, Read underwriting syndicate, since their bid represented the lowest net interest The reason the issue generated headlines was that it paid 50% interest per year for bonds maturing in the first four years after issue. Bonds maturing in later years paid lower interest rates, and bonds maturing after 1986 promised to pay 0.1 per year. Hopewell, Kaufman, and West [3] estimate that Minnestoa's use of the interest cost method will cost the state an extra $1 million. In municipal issues bonds maturing early generally carry a relatively higher interest rate than those maturing in later years. The motivation for such payout arrangements lies in the use of the interest cost method of computing the cost of the bond issue. While the Minnesota issue attracted a great deal of attention, this type of issue is not rare. For example, in November 1972, Harford County, Maryland, awarded $6 million of bonds to a syndicate headed by Chase Manhattan Bank where the interest rate was 7% for ten years and then declined to 1/10% for bonds maturing in 1997. Once or twice a week tombstones published in the financial newspapers announce similar types of issues. It will be argued here that the use of interest cost introduces an undesirable bias into the decision process. If we assume that the investment banking community understands the nature of the bias, but that municipal and state financial officers do not, then this is an undesirable situation. The governmental financial officer thinks he is accepting the lowest cost offer but may actually be accepting an offer that can easily be the highest cost. Rules of thumb tend to be accepted when they give reasonable results for recurring situations. The interest cost method used by investment bankers is such a rule of thumb and the effects of using the calculation seem to be acceptable to practitioners. The results are consistent with the actuarial yield of the bond, if the calculations are applied to one bond issue paying the same amount of interest throughout the life of the bond. If there are serial bonds paying greatly different amounts of interest, the measure is unreliable. It has been criticized in the theoretical literature [e.g., 5] but continues to be used in practice." @default.
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• W2034159715 date "1972-01-01" @default.
• W2034159715 modified "2023-09-27" @default.
• W2034159715 title "Alternative Debt Bids by State and Local Governments" @default.
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• W2034159715 doi "https://doi.org/10.2307/3665371" @default.
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