After reading a blog entry the other day, I thought it might be helpful to explain how t0 calculate the yield that you are receiving on an investment.
First off, in this example, you are investing in an existing cash flow instrument where the monthly payment amount, number of payments and the interest rate is fixed. I will attempt to explain how you go about determining what amount you will invest to receive a specific yield.In most cases, the yield that you want is larger than the face interest rate on the instrument and therefore you will purchase the instrument at a discount from the actual face value of the instrument.
In most cases, the yield you want is larger than the face interest rate on the instrument and therefore you will purchase the instrument at a discount from the actual face value of the instrument.
For example, let’s say that someone has a promissory note with a balance owed of $10,000 with 10% interest and monthly payments of $212.47. If you have a financial calculator you will notice that it has the following five keys, N, I/YR, PV, PMT, FV. If you have any three of the entries, you can figure the other two. In the above example, you could input 10,000 and press the PV key, 10 and press the I/YR key and -212.47 and press the PMT key; now you can solve for the N key or the number of payments of $212.47 needed to pay off $10,000 at 10% interest. You should get 60 meaning that this instrument will pay off in 60 monthly payments or five years.
Once you have this information, you can decide what yield you want, and then that will determine how much you will invest in this note. If you decided that you wanted a 12% yield, you would put 12 into the I/YR key and solve for PV, and that would tell you that you would invest $9,551.62 to purchase this instrument and that investment would yield a 12% return over 60 months.
This is a very brief explanation of how to calculate yield, and there are many other factors that may go into an investment of this sort, but hopefully, it will give you an idea of how to determine the investment you are willing to make assuming you want to receive a specific yield.
As always, you should consult your attorney or CPA before investing. If you want to know more about this concept in an easy to understand book, I would suggest “Invest in Debt” by Jim Napier. Click here to see the book on Amazon.com.