I'll preface this by saying I'm a newb, which should be evident by my question. I've read the other posts explaining what the difference between the user anticipated calc of ROI is and how YTM is calculated using ammortization. I suppose I don't understand it entirely but my main question is:
Why should I care what the YTM is if it doesn't accurately reflect my anticipation of the annualized ROI? How is it useful?
For example:
Asking price of loan is $9 for a loan with 12 payments left that total $9.60 (assuming borrower pays as scheduled). YTM says 9.32%
while the 60 cents I make on the investment is more like 6.66%.
Thanks in advance
Your return calculation is ignoring the income you could earn from reinvesting the repayment of principal during the year. Presuming you can reinvest it in similar notes (and assuming the borrowers make their scheduled repayments should close the gap between ROI and YTM.
Thanks for the reply. So YTM assumes reinvestiment. Got it. Thx
I think it's not exactly that reinvestment is assumed but that the principal invested in the loan decreases with each monthly payment. That amount of principal is returned to you each month. You may or or may not decide to reinvest; YTM doesn't care. YTM just knows that, per the monthly amortization schedule, you are loaning less and less money (outstanding principal) each month. That being true then clearly the YTM interest rate will be higher to return the same $0.60 over a years time than your example "ROI" which is based on the full $9.00 remaining invested the entire year. Since LC loans are amortizing then YTM is best measure for comparison of returns.
The same is true for freshly bought new loans. If I purchase a new 36 month $25 note with a 10% APR that is faithfully paid back each month for 3 years I will receive $4.04 interest. If you compute "ROI" on the entire $25 given $4.04 interest it's a total return of about 16.2% or roughly 5.4% annualized.
For apples-to-apples ROI should be computed on the amount of money you actually have invested each month and not the starting amount. In that case I think ROI and YTM are the same.