Posted by John Behle on August 29, 2005 at 16:46:31:
It’s present value is what the market would bear. IF you could sell the note, what would people pay. But, just from a calculator exercise point of view, let’s look at some numbers.
Using your numbers above, I solve for interest rate on the note and it is 11.63% Since the compensating note is just a pass through, let’s look at your yield on the $5000 invested in the first 180 payments.
You have: PV=-5000 N=180 PMT=100 FV=-0-
Solve for %I and you get - 23.24% as your yield.
Pretty slick when you are paying half of the face value for half of the note. And people say you can’t get good yields these days.
The value of the compensating note is just it’s value in the marketplace. Considering there are no payments for 15 years, buyers may be sparse, but let’s assume someone with an IRA might have an interest at 15%.
There are three different ways to calculate for the value. The easiest is the subtraction method. You simply figure the value of the whole note and then subtract the value of the first half and that leaves you the value of the second half (don’t try this if you’re from Canada).
Value of the whole note
N=360 PMT=100 I=15% FV=-0-
PV then equals $7908.61
Value of the first half - just change N to 180 and recalculate for PV to get $7144.96
Subtract 7144.96 from 7908.61 and you come up with the value of the second half of:
$763.65
That’s the value of 15 years worth of payments of $100 per month that doesn’t begin for 15 years at a 15% yield.