In this exercise, you will learn how to buy notes with balloon payments that grow in value as time passes.
You inherit some money from your rich Aunt Harriet. You decide to buy the following note with this newfound cash.
Fill the known parameters and use your financial calculator to calculate the face interest rate on the note:
You need to buy this note to yield you 16% to show your aunt you are a wise investor.
Calculate the PV, which is your purchase price for the note. I/Y is now your yield of 16%.
You hold the note for 12 months, and then have to sell the note to pay your taxes because you are making so much money as a note broker. You find an investor friend you met at a convention. He agrees to buy the note from you, but demands the same 16% yield you bought the note for. He thinks you shouldn’t earn a profit on a fellow note broker.
There are 36 (N) months remaining, since 12 payments have been already been made. The yield the note broker is demanding is 16%.
Calculate what the note broker will have to pay to buy this note from you.
This is the new note broker’s purchase price.
In one year this note has increased in value $3,207.03!
What You Have Learned: A Balloon Note that is bought at discount actually increases in value as the balloon date gets closer. You could buy a note with a balloon and then resell it later for more than you paid for it without increasing its yield.
Box #1: I/Y = 8.5%
Box #2: PV = –58,459.94
Box #3: PV = –61,666.96