Real Return Methodologies

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    June 12, 2018

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    June 13, 2018

    RRM financing features fixed real payments and fixed real returns that remove risk from the financing process and create value for both borrowers and lenders.  RRM uses a patented process for creating and servicing an equivalent nominal-dollar instrument.  The explicit specification of an equivalent nominal-dollar instrument provides financial professionals the nominal-dollar interest rates, interest amounts, payment amounts, and principal balance amounts they need to create financial statements and to calculate taxes.

     

    Because it is an equivalent instrument, the RRM fixed real payments translate into nominal-dollar payments that always exactly amortize the nominal-dollar principal balance -- regardless of how the nominal-dollar interest rate (and, therefore, the nominal-dollar interest amount) varies with inflation.

     

     

    This spreadsheet: RRM Basic Fixed-Rate Financing

     

    There are two plys to this spreadsheet.  (This is a copy of the first ply.   A summary to assist you in the use or building of the second ply, the calculations.)  The second shows calculations and comparison of a basic RRM financing to a conventional fixed nominal rate finance.

     

    The purpose of this spreadsheet is to provide a simple example of an RRM loan and compare it to a conventional fixed nominal rate loan.  In this simple example of an RRM financing, annual payments are used, amortization is reduced to 10 years, and inflation adjustments are performed using the current year's inflation rate, thus eliminating any lags in adjustment to inflation (in actual practice, the adjustment lag cannot be reduced to less than 1 - 2 months given the fact that inflation numbers are released monthly).

     

     

    This simple example clearly shows the conversion of a fixed real financing instrument (fixed real interest rate, fixed real payments and fixed real amortization into an equivalent nominal-dollar instrument).  The fixed real financing instrument is defined by the loan amount (enter loan amount in cell D6), the fixed real interest rate (enter the fixed real interest rate in cell D9), the payment frequency (fixed at one per year) and the amortization in years (fixed at 10 years).  The payment function is then used to calculate the fixed real payment (column J) and the fixed real interest rate and the fixed real payment are then used to calculate the fixed real amortization (column L).

     

    The first step in creating the equivalent nominal-dollar instrument is to calculate the equivalent nominal payment (column E) by multiplying the fixed real payment (column J) by the inflation factor (column I).  The inflation factor for year 1 equals 1 plus the inflation rate for year 1.  The inflation factor for year 2 equals the inflation factor for year 1 times 1 plus the inflation rate for year 2, etc.

     

    The second step is calculating the equivalent nominal interest rate (column D).  The equivalent nominal interest rate for year 1 equals 1 plus the fixed real rate of interest times 1 plus the inflation rate for year 1, this quantity minus 1. The equivalent nominal interest rate for year 2 equals 1 plus the fixed real rate of interest times 1 plus the inflation rate for year 2, this quantity minus 1, etc.

     

    The third step is to use the equivalent nominal payments (column E) and the equivalent nominal interest rates (column D) to calculate the nominal dollar amortization (column G).  The remaining nominal-dollar principal balance at the end of year 1 equals 1 plus the equivalent nominal interest rate for year 1 times the loan amount, this quantity minus the equivalent nominal payment for year 1.  The remaining nominal-dollar principal balance at the end of year 2 equals 1 plus the equivalent nominal interest rate for year 2 times the remaining nominal-dollar principal balance at the end of year 1, this quantity minus the equivalent nominal-dollar payment for year 2, etc.

     

     

    To see that the resulting nominal-dollar amortization (column G) is equivalent to the fixed real amortization (column L), create a scratch column N that converts the nominal-dollar amortization amounts into equivalent real amounts.  The equivalent real amount (column N) equals the remaining nominal-dollar principal balance (column G) divided by the inflation index (column I).  Notice that the numbers in column N equal the numbers in column J, thus demonstrating that the RRM technology did indeed create an equivalent nominal-dollar instrument.

     

    Create different inflation scenarios by entering any desired inflation numbers into column B. (For quick access to inflation data, we list St. Louis Fed data from 1917-2017 in a column to the far right, but choose any index you determine best to test, GDP as a suggestion and note the method is effective in any marketable currency.)  Demonstrate to yourself that the RRM technology always works.  When entering high initial inflation rates, adjust the fixed nominal interest rate of the nominal fixed loan (cell I9) to reflect the higher inflation (the nominal rate equals the real rate plus the expected inflation rate plus the inflation risk premium) and see how the payments of RRM financing always remain affordable, regardless of how high inflation and nominal interest rates go.  In fact, the higher the initial rate of inflation, the greater the affordability advantage of RRM financing.

     

      *RRM nominal rate of interest = Inflation Index agreed upon + X% + Inflation Index agreed upon × X% where X is the fixed, real rat agreed upon.  A cross product is utilized to address ‘lags’ in inflation reporting.

     

     

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