Can someone please help me clarify something about rate of returns.
Let say I lend money to someone $100 for 5 years at 12% per year.
If I lend it at annual amortization, I will get $12 in the first year as interest. My return on capital is 12%.
If I lend it at monthly amortization, I will get $10.28 in interest in the first year. My return on capital 10.28%
What is the 10.28% called?
Your capital outstanding doesn’t remain constant in #2
Right. The capital outstanding is $85.81.
10.28/85.81 = 11.979%
OP: I’m trying to reproduce your interest and principal figures and am having difficulty.
FYI, here’s what I get using my trusty BA II:
N=60, PV=100, set to END
P/Y=C/Y=12 PMT = 2.2244 First year interest 11.16 principal = 84.47
P/Y=12, C/Y =1 PMT = 2,1935 First year interest 10.58 principal = 84,259
As rawraw pointed out, the outstanding principal will change with each payment, so in your monthly example, it is not correct to assume that the outstanding principal is $100 for the whole year when calculating the rate of return. As a matter of fact, the outstanding principal will always earn 12%.