True Interest Cost

In a COMPETITIVE municipal bond sale, the issuer awards the bonds to the syndicate whose bid:

1. A.Produces the lowest net or true interest cost as specified in the notice of saleCorrect. Interest-cost minimization is the award standard.
2. B.Arrives first at the issuer's officeWrong. Timeliness qualifies bids; cost wins them.
3. C.Includes the largest underwriting spreadWrong-but-tempting. Spreads are the SYNDICATE'S economics - the issuer compares its own cost.
4. D.Offers the highest coupon ratesWrong. High coupons RAISE the issuer's cost.

Why: Competitive sales are awarded on lowest net or true interest cost per the official notice of sale; TIC incorporates the time value of money while NIC is the simpler aggregate calculation. Citation: competitive sale award procedures; notice of sale terms. Takeaway: cheapest borrowing wins - by the notice's stated cost formula.

Two syndicates submit bids on the Ashfield Regional Sanitary District issue. The notice of sale states that the bonds will be awarded to the bid producing the lowest TRUE INTEREST COST rather than the lowest net interest cost. What is the difference between the two measures?

1. A.True interest cost includes the underwriter's gross spread while net interest cost excludes itBoth measure the issuer's interest cost; neither is defined by the spread.
2. B.Net interest cost discounts future payments while true interest cost ignores timingThis reverses the two methods.
3. C.True interest cost ignores the maturity schedule entirely and looks only at the average couponTIC depends heavily on the maturity schedule, since the timing of each payment drives its present value.
4. D.True interest cost discounts the debt service payments back to the sale date, recognizing the time value of money, while net interest cost simply totals interest adjusted for premium or discount and divides by bond yearsCorrect. Present value discounting is the defining difference between the two measures.

Why: Net interest cost is a simple arithmetic measure: total coupon interest payable over the life of the issue, increased by any discount or reduced by any premium, divided by bond years. It treats a dollar of interest paid in year one exactly like a dollar paid in year twenty. True interest cost discounts every debt service payment back to the sale date, so it recognizes the time value of money and rewards a bid that pushes interest expense further into the future. Because the two methods weight the maturity schedule differently, they can award the bonds to different syndicates on the same set of bids.