There is a 1st lien (deed of trust)on a property which looks like
this. PV(balance of note) is $13586.interest is 8% (per annum) ,
payments are $175. p&I  monthly (no stop or balloon). If I buy this
note with ONLY one payment of 13586 due in 5years, what is my yield?
Yes, the income stream starts coming to me now!

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Request for Question Clarification by omnivorous-ga on 04 Dec 2003 08:08 PST

Lucyfur --

It's not clear what payments are here:
*  annual 8% payment of how much?  It's $1,087 -- paid annually?  Or
is it 8% on a larger value?
*  what payments are $175?  It appears that you're assuming the
property -- and paying the full amount ($13,586 in 5 years). . .

Best regards,

Omnivorous-GA

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Clarification of Question by lucyfur-ga on 05 Dec 2003 05:12 PST

Omnivorous, Hi there from sunny Arizona. I'll try to clarify my
question for you. First of all, the interest is 8% annual or .666
monthly. Next, Payments of $175. are part principal and part interest.
These payments are made monthly. Since  principal is paid every month
the remaining balance goes down every month leaving a smaller balance
for the interest to be computed on. This is how most real estate loans
 are figured. Next, you said "it appears that you're assuming the
property". I would not be buying the property only buying the note
(lien) against the property. I would be buying this note with only one
payment of 13586. To be paid in 5 years. But I would be getting the
payments starting now. I hope this helps. lucyfur-ga

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Request for Question Clarification by omnivorous-ga on 05 Dec 2003 07:38 PST

Lucyfur --

Your yield is fantastic because you get all of the principal payments
ahead of time!

Strictly speaking the yield is 8% -- with regularly monthly P&I.  What
makes this unusual is your balloon at the end: this is the piece that
a financial analyst would discount to a net present value (NPV). 
After all if you had about $10,650 TODAY and put it in T-bills
(risk-free rate), it would grow to $13,586 after 5 full years.

You could refer to the NPV as a yield -- it truly is in a "wealth
increasing" sense.  And it is a deal that any sensible investor would
make in today's interest rate climate.  However, legally the
definition of yield would probably remain 8% -- the payoff on an
existing obligation (the lien).

Here's what I'd propose: I'll use current T-bill rates to provide that NPV.

And you aren't teasing me about being in rainy old Seattle, are you?

Best regards,

Omnivorous-GA

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Clarification of Question by lucyfur-ga on 08 Dec 2003 21:40 PST

The answer should be based on the time value of money and expressed by
an interest rate (%)

Lucyfur --

There are a variety of ways to computer a yield:
?	Net present value (NPV)
?	Yield-to-maturity
?	Rate-of-return (which really doesn't work here)
?	Internal rate of return

If you want to see the theory behind each (and some problems that
compare differences in each method), you might want to see this Google
Answer that I completed yesterday:
"Economics Help" (Omnivorous-GA, Dec. 8, 2003)
http://answers.google.com/answers/threadview?id=284273

I've set up a spreadsheet to use Excel's NPV and IRR functions here. 
You might wish to download it, as we try to clean up files on the
server periodically:
http://www.mooneyevents.com/discounted.xls

In any case, the yield here is NEGATIVE.  You're receiving payments of
$10,500 -- but they have a lower NPV -- which is shown in the chart as
$8,696.

The NPV of $13,586 is calculated this way:
NPV = $13,586/(1 + i) ^ n

where, 
i = interest rate
n = number of years

NPV = $13,586/1.08 ^ 5
NPV = $13,586/1.4693 = $9,246  -- more than the NPV of the payments
you're receiving.

The IRR comes out negative simply because payments don't accumulate to
enough -- even in non-discounted dollars -- to pay off the balloon.

Now, a couple of notes:
*  the monthly interest used in the spreadsheet calculation is
actually 0.64%, not 0.666%.
Twelve monthly payments of 0.666% is actually a yield of 8.3% (1.00666 ^ 12).
*  the difference between the spreadsheet's $9,206 and the $9,246
shown above is due to rounding errors of using 0.64% over 60 months
(vs. 8% over 5 years).
?  calculating your yield on this is done this way:
(NPV balloon - NPV payments)/NPV balloon 
(-$510) / $9,206 = -.0554 = - 5.54%

Best regards,

Omnivorous-GA

I still don't have an answer. We have failed to communicate.The
answerer mentions a balloon, there is no balloon only a one time
payment. This question was meant for an invester who buys discounted
notes.