The Right Interest Rate Could Save Your Life

[Andy Nguyen]

From FEN. Very amusing story of how someone almost died in prison because of a wrong interest rate:toimonster:

The Right Interest Rate Could Save Your Life by Andrew Kalotay, Ph.D.

Over the past few years I had communicated frequently with Joseph Galluzzi, former treasurer of Essex County, New Jersey. But we did not meet face-to-face until recently, following his release from a federal penitentiary.

Mr. Galluzzi was convicted in 1998 (Securities and Exchange Commission 2002) of taking kickbacks from underwriters of a certain county bond deal and apparently faced two to three years of jail time. However, during the sentencing phase of the trial the prosecution introduced some Essex County documents showing that the transaction lost several million dollars. The judge viewed this as a substantial financial harm to the county and dealt out a much harsher sentence of seven and a half years.

I had been brought in to assist with Mr. Galluzzi's case after the failure of his first appeal. Because I was familiar with the mechanics of the type of transaction involved, a so-called advance refunding, I was certain that the calculations indicating a large loss were erroneous. There was no way to lose that much even if one tried (Finnerty 1988)!

The culprit, as it turned out, was the discount rate, a widespread source of confusion in the world of tax-exempt bonds. The transaction definitely did not lose money. On the contrary, one could argue that the maturity extension actually lowered the cost of the County's liabilities.

I was looking forward to exposing the discounting error, hoping that it would make the case for reducing Mr. Galluzzi's sentence. But I had been brought in too late. Apparently in a federal case the only recourse after the first appeal is the Supreme Court, where only matters deemed of constitutional significance have a chance of being heard. While the wrong discount rate was of critical importance to the outcome of the Galluzzi case, it obviously lacked constitutional ramifications.

When I met him after his release, Mr. Galluzzi told me that prison officials had refused him treatment for a life-threatening condition until his congressman finally came to his aid. It struck me that here was a man who almost lost his life because of the wrong discount rate.

Read the whole article here

 

[nonoah]

yes, discount rate is important.

Somehow the system ask me to post something (Andy, you really did the best job about the web site), so here it is.

Once on a interview, I was ask what is a discount factor, given I just finish Kosygina 's stochastic calculus class, I said something like:

discount factor is the thing that if one multiples it to a security, then in a
risk-neutral world, the whole thing becomes a martingale.

to which the interviewer plause for 3.14159 seconds and said:

" err..., a discount factor is used to discount future cash flow to its PV",

"Oh, yeah, sure, that too."