Posted by Sean on January 09, 2001 at 09:20:33:

Fuzzy math! The point you need to realize is that in scenario 3 you are mis-stating the amount of the investment. You are saying $885/year divided by the $10,000 invested, but at the end of the first year do you still have $10,000 invested?

No. With the very first payment the borrower has reduced your investment by paying some of the principal. To properly calculate your yield for the first year without a financial calculator you’d need to work out the average investment by calculating the principal at the end of each of the 12 months and dividing by 12 to get the average. Under those circumstances I think you’ll find that the yield is still 16%

Consider this scenario instead: You have those 2 notes all for sale at $9,000 (Example 1 and 3). Which is the best note to buy under the circumstances?

Note 1 yield: PMT=133.33 PV=9000 (what you’re paying) nper=36 FV=10000. Solve for i% -> 20.5%

Note 2 yield: PMT=351.57 PV=9000 nper=36 FV=0. Solve for i% -> 23.7%

Accordingly we can conclude that note 3 is the better note and that note 1 would need to come down in price before we’d be interested.