Interest rate calculations

3 Replies

I know there has been very detailed posts in the past regarding the differences between Yield, IRR and how to calculate them. For what I am doing however, I am a little confused on which metric I should refer to for accurate results. I am using a compound interest calculator to project future cash flows based on discounted note's I am buying.

A compound interest calculator naturally has an input field for "interest rate". My question is this: Would it be prudent to enter the "Yield" I am getting from my note, or the cumulative "IRR" calculation which is more detailed and covers the entire note from beginning to end? Note that these two calculations are rarely the same.

Which is a more accurate reflection of "interest rate" in this case?

I am simply trying to project future cash flows based on my note purchases. My thinking is Yield is the correct answer because it is the actual amount of cash I'm receiving from each payment. I'd like to hear more advanced investor feedback on what is the best way to think of this accurately.

Your thoughts?

- Josh

Hi Josh - Perhaps I am misunderstanding your question. Your future cash flow is defined by the interest rate and P&I payment on the note itself and your purchase price has no bearing on that.  Your yield, however, can be different if you pay something other than face value (unpaid balance) for the note but this has no impact on future cash flows. 

For example, let's say you purchase a brand new 100K note with an interest rate of 9% with a 30 year amortization.  They monthly payment on that will be $804.62 and that is the payment you will get, regardless of what you pay for the note.  If you purchase this note at for 70K, your yield is 13.55% due to the fact that your investment is less than face value.

It is not clear what you are trying to solve for.  That will matter to some degree.

Thank you for the feedback. I believe I have answered my own question after some amount of  thinking. Possibly I should think a little deeper before posting :)

- Josh

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