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Okay, time for part 3.  To recap, the scenario from Part 1 and Part 2 is as follows: <!–(Part 4 and Part 5 come next)–>

THE SCENARIO

I came across a note for sale.  The terms of the note are as follows:

Original balance: \$6,000

Unpaid balance as of June 2: \$4,560

Term: 5 years

Interest Rate: 0

Payments: \$100 per month

If I buy it, make the purchase on June 2, and the first payment I’ll receive will be the July payment.

Every February, the borrower pays off \$1,000 in order to accelerate the note paydown.

QUESTION

The current owner of the note wants to sell me the note for 15% off its face value (85% of \$4,560 = \$3,876).

If I buy, what will my yield be if the borrower pays normally but without his extra lump-sum payment every February?

SOLUTION

I can do this with normal a Time Value of Money calculation.

N is 45 (\$4,560 divided by \$100, rounding down).

PV is -\$3,876

PMT is \$100

FV is \$60

Here’s the problem setup:

Solving for I/YR, I find that my yield is 8.63%.

Here’s what the cashflow diagram looks like:

Money Blog – How discounted is that note really? Part 3
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