No. of Recommendations: 1
I'll give another example. Let's say that on 1/1 you loan me $100 and we agree to a 10% interest rate with the interest being paid immediately and that I have to pay you back by 12/31. Do we agree that your return/yield on your $100 is 10%?
But it ISN'T 10%!!!
He is loaning $90 ($100 - $10) on 1/1 and you are paying back $100 on 12/31. That's more than 10%, it's closer to 11.1% (IRR).
Time goes by and it is 12/31 and I don't have the $100 to pay you. You're flexible. You say OK how about if we extend the loan 1 year but you have to pay me $12 this time and can pay me back the $100 on 12/31 of next year.
What is your return/yield on your $100 in year 2? I could be wrong but I would say that it is 12%. Are you going to tell me that it is still 10%?
Again, it isn't correct. In the second year, he is loaning $88 ($100 - $12) on 1/1, and receiving $100 back on 12/31. That would be a yield of about 13.6% (IRR).
