Time Value Of Money III...Continued

PV:  Present Value:  The value of a dollar today due in the future or in a series of payments, to give an investor a certain yield over a period of time.   

FV:  Future Value:  The value of a dollar at some time in the future from a lump sum payment, or series of payments. A simple example would be a balloon payment due in 5 years, or how much would you have if you saved one dollar a month for five years at 6% compound interest. 

%i:  Yield:  This term is often interchanged with rate of return or interest. 

N:  Number of pay periods: The total number of periodic payments on a note. Usually in terms of months. It can be years, quarterly, semi-annually, or even weekly. 

PMT:  Amount of payments:  The amount of dollars received or paid out in periodic payments to achieve a certain rate of return, and to amortize a loan. 

In last month's issue, we learned about the relationship of N to PMT.  We discovered that N and PMT have an inverse relationship. The EDUCATION section gives you some practical real life applications to increase your yield, and make you richer.  

In this issue, The Professor will discuss how N relates to yield. Whether N is a large number as in 30 years or a small number as in one month, knowing how to tweak these variables will enrich your returns. 

As a general rule, when dealing with a series of payments, when you increase N, you will increase your yield. Here we are concentrating only on monthly payments because this is the most common.  Think about this a second and let it settle in. Let's set up a note so you can actually see the relationship. Assume we have a $10,000 note payable at 10% interest over 15 years or 180 months. What would this look like? 

  N                 %i                        PV                      PMT                     FV

180               10                      -10,000                 107.46                    0 

Now let's look at what happens when we keep everything the same, but increase N to 30 years. 

N                 %i                        PV                      PMT                     FV

360            12.59                    -10,000                 107.46                   0 

In other words, there is a direct relationship between N and yield when dealing in monthly payments.  Did you see how if we kept the payments the same, and increased N, then our yield increases from 10% to 12.59%. But Professor, this is not realistic, you say. No one is going to give up extra payments. This is true, unless it is disguised. Then you would be surprised to see how many fall into this trap.  In the "For The Greedy Only" there is a real life application of how some note buyers will use this concept to extract astronomical yields from note sellers when buying partials. After reading THE NOTE PROFESSOR, you will be armed with knowledge that will prevent you from falling into that trap, as other amateur note sellers often do. 

How about balloon payments? Does the same relationship apply?  No!!! In fact the relationship is just the opposite; there is an inverse relationship between N and yield.  When dealing with balloon notes, a decrease in N will increase yield, and visa versa.  Let's look at an example of a balloon note to give an idea of this concept. Say we had a $10,000 note balloon note due in 180 months. Let's assume we paid $5000 for that note. Here is what it would look like.                

  N                 %i                        PV                      PMT                     FV

 180              4.63                    -5000                       0                     10,000 

Say we decrease N to 5 years, or 60 months. What affect does this have on the yield? 

 N                 %i                        PV                      PMT                     FV

 60              13.94                    -5000                      0                      10,000 

Take time to think about this concept. Does it not make sense that if I receive $10,000 in 5 years, the yield will be greater than if I received the same $10,000 in 15 years. What are the practical applications? In the 0 Coupon Bonds and Balloon articles (link to education section), The Professor gives numerous ways to use this concept to your advantage, and to enhance your riches. You will also learn ways to avoid the traps of balloons.  

To review, when dealing with monthly payments, there is a direct relationship to increasing N and increasing yield. When dealing with balloon notes there is an inverse relationship. When N decreases, yield increases, and vice versa. 

In the next issue, THE PROFESSOR will discuss the relationship between N and PV. BIG, BIG PROFITS to be made knowing this concept.  

If you have questions or comments, CONTACT THE PROFESSOR. 

Be Sure to Consult an Attorney and CPA when doing any business transaction.