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Maturity Structure and Borrowing Costs: The Implications of Level Debt Service  


Author:  Mark D. Robbins.; Bill Simonsen.; Bernard Jump, Jr..


Source: Volume 21, Number 03, Fall 2000 , pp.40-64(25)




Municipal Finance Journal

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Abstract: 

The purses of citizen taxpayers sink and float with the financial condition of an issuing municipality as well as with its certification decisions. This article considers another cost factor: the structure of the issue itself. It certainly makes intuitive sense that how a bond issue is structured should make a difference to its present value cost—as any dollar of spending deferred costs less. The complexities of issuance in practice, however, muddle where such intuition leads us. The authors look at two common structures, equal principal and level debt service, to determine their effects on true interest cost, adopting a simulation approach in order to isolate specifically the influences of structure. The result: level debt service imposes a cost penalty compared with equal principal in typically increasing coupon structures. Bond issues carry many other common features that complicate this—for instance, the use of original issue discounts tends to increase the true interest cost associated with issues—but this affect is mitigated in the presence of level debt service structures. The authors contrast the effects of structure on issues sold at a discount or a premium or with deferred principal payments using both simulated data and that from actual issues. The costs impacts are substantial and worthy of the attention of professionals. While debt managers may have other objectives than cost savings when choosing a structure (e.g. the desire to ‘wrap around’ outstanding debt schedules), this information can guide them about the cost implications of their decisions.

Keywords: True Interest Cost (TIC); maturity structure; equal principal (EP); level debt service (LDS)

Affiliations:  1: University of Georgia; 2: University of Oregon; 3: Syracuse University.

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