The true interest cost of municipal utility district securities, 1973-1978



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The True Interest Cost of Municipal Utility District Securities is a present value method of calculating the interest rate. It is used as the dependent variable in a model of the market for tax-exempt securities issued by special districts located in Houston's suburban areas. The model is estimated over the 1973-1978 sample period using ordinary least squares (OLS) regression analysis. Two important conclusions are derived from the literature review chapter: all the models developed to explain the interest cost of state and local debt have net interest cost (NIC) as the dependent variable, and the determinants of NIC can be sorted into four basic categories. The problem with NIC is it is not a present value method of calculating interest. With this in mind, the relative merits of true interest cost (TIC) in lieu of the NIC convention for awarding municipal bonds is explained. Then, given the same information required to calculate the NICs, the TICs of the corresponding serial issues of municipal utility districts were calculated. Unlike NIC, TIC has an economic justification. TIC is used as the dependent variable for the models considered in this study. It is specified to be a function of a rating dummy variable and three vectors representing the market conditions, the characteristics of the issue, and the community attributes of a municipal utility district (MUD) when offering its serial bonds. The NIC and TIC of MUD bonds are compared with the Daily Bond Buyer's 20 Bond Index and Government Bond Index, respectively. The 1973-1978 data set is subdivided into 1974-1975, and 1976-1978 samples. The former sample represents a period of relatively high interest rates when an interest rate ceiling imposed on MUD bonds by Houston became effective. Throughout the analysis the structural difference between MUDs and other municipal governments is stressed, leading to the specification of a unique model for MUD securities. OLS parameter estimates met hypothesized expectations when considering the entire 1973-1978 period or when interest rates were relatively low (1976-1978). However, the same regressions were run over the (1974-1975) sample resulting in certain estimates having ambiguous signs or losing their statistical significance.