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Purchasing loan parts at a premium/mark-up or discount/mark-down

Loan parts purchased at a premium 
Sale price = outstanding principal * (1 + premium %) + accrued interest 
If you purchase a loan part at a premium you pay more for the loan part than the outstanding principal and accrued interest. This means the Buyer Rate is lower than the original interest rate of the loan part.

Loan parts offered at a discount 
Sale price = outstanding principal * (1 - discount %) + accrued interest 
If you purchase a loan part at a discount you pay less for the loan part than the outstanding principal and accrued interest. This means the Buyer Rate is higher than the original interest rate of the loan part.

Fully Worked Example – Secondary Market buying 
Assume a loan part has 36 payments remaining, principal outstanding of £80, original interest rate of 9.1% and accrued interest of £0.03 (ie, 2 days interest).

If it is offered at par (no premium or discount) this will result in: 
Buyer Rate = 9.1% 
Sale price = £80 * (1 - 0%) + £0.03 = £80.00 + £0.03 = £80.03

If it is offered at a 3% premium this will result in: 
Buyer Rate = 7.1% 
Sale price = £80 * (1 + 3%) + £0.03 = £82.40 + £0.03 = £82.43

If it is offered at a 3% discount this will result in: 
Buyer Rate = 11.2% 
Sale price = £80 * (1 - 3%) + £0.03 = £77.60 + £0.03 = £77.63

The graph below shows the return experienced if the loan was fully repaid early at different points during the loan period. You can see that an investor who bought at the premium of 3% would receive a negative return if the loan was fully repaid within the first 3 months of purchase. This demonstrates the pre-payment risk of buying loans at a premium and the pre-payment advantages of buying loans at a discount.

Ex graph_1.JPG 
 

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