Promissory Notes, Simple Discount Notes, and The Discount Process Chapter Seventeen Promissory Notes, Simple Discount Notes, and The Discount Process McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning unit objectives LU 17-1: Structure of Promissory Notes; the Simple Discount Note Differentiate between interest-bearing and non-interest-bearing notes. Calculate bank discount and proceeds for simple discount notes. Calculate and compare the interest, maturity value, proceeds, and effective rate of a simple interest note with a simple discount note. Explain and calculate the effective rate for a Treasury bill. LU 17-2: Finding the Face Value, Rate, and Time for a Simple Interest Note and a Simple Discount Note Find the face value (principal), rate, and time of a simple interest note. Find the face value (maturity value), bank discount rate, and time of a simple discount note.

Learning unit objectives LU 17-3: Discounting an Interest-Bearing Note before Maturity Calculate the maturity value, bank discount, and proceeds of discounting an interest-bearing note before maturity. Identify and complete the four steps of the discounting process. 17-3

Structure of a Promissory Note 17-4

Simple Discount Note Terminology Simple Discount Note -- A note in which the loan interest is deducted in advance. Bank Discount -- The interest that banks deduct in advance. Maturity Value – The total amount due at the end of the loan (the sum of the face value, or principal, and interest). Proceeds -- The amount the borrower receives after the bank deducts its discount from the loan’s maturity value. Bank Discount Rate -- The percent of interest. 17-5

Simple Discount Note Pete Runnels has a choice of two different notes that both have a face value (principal) of $14,000 for 60 days. One note has a simple interest rate of 8%, while the other note has a simple discount rate of 8%. For each type of note, calculate (a) interest owed, (b) maturity value, (c) proceeds, and (d) effective rate: (See next slide for solutions) 17-6

Comparison of simple interest note and simple discount note Scenario Face value = $14,000 Interest rate = 8% 60 days 17-7

Comparison of simple interest note and simple discount note 17-8

Treasury Bills Effective rate = $200 = 8.16% $9,800 x 13 52 A Treasury bill is a loan to the federal government Terms of Purchase: 28 days (4 weeks), 91 days (13 weeks), or 1 Yr. Purchase Price (proceeds) of a Treasury Bill = The value of the Treasury bill - the discount. Example: If you buy a $10,000, 13-week Treasury bill at 8%, how much will you pay, and what is the effective rate? 13 52 $10,000 x .08 x = $200 Cost = $10,000 -- $200 = $9,800 Effective rate = $200 = 8.16% $9,800 x 13 52 17-9

Finding the face value, rate, and time for a simple interest note Maturity Value Formula (Chapter 16) M = P(1 + RT) Averi Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value (P) and interest (I) for the simple interest note. P = M 1 + RT = 2,550 1 + (.06 X 150/360) = 2,550 1,025 P = $2,487.80 P 17-10

Finding the face value, rate, and time for a simple interest note Averi Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value (P) and interest (I) for the simple interest note. Maturity Value Formula (Chapter 16) M = P + I I = M - P I = $2,250 - $2,487.80 I = $62.20 17-11

FINDING RATE Averi Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value and interest for the simple interest note. R = I PT R = $62.20 $2,487.50 X 150/360 R = $62.20 $1,036.46 R = .06 17-12

FINDING TIME (IN DAYS) T (in days) = I X 360 PT T = $62.20 $149.27 X 360 T = 150.01 days (off due to rounding) 17-13

Finding the face value, rate, and time for a Simple discount note Averi Walker borrowed $2,250 at 6% for 150-days to pay off a personal loan. Find the proceeds and interest for the simple discount note. Pr = M(1 – DT) B = M - Pr Pr= $2,550 [1 - .06 (150/360)] B = $2,550 – $2,486.25 B = $63.75 (bank discount) Pr = $2,550 (1 - .025) Pr = $2,486.25 (proceeds) 17-14

Finding rate D = B ―― MT D = $62.20 $2,487.80 X 150/360 D = $62.20 $1,036.59 D = .06 17-15

FINDING TIME (IN DAYS) T (in days) = B X 360 MD T = $62.20 $149.27 T = 4167 x 360 = 150 days 17-16

Finding face value for desired proceeds M = Pr 1 - DT Mallori Rouse needs $3,000 to drywall her master bedroom. Find the face value of a simple discount note that will provide her with $3,000 at 6.5 % for 85 days. M = $3,000.00 (1 - .065 x 85/360) M = $3,000 .984752778 M = $3,046.76 17-17

Discounting an Interest-Bearing Note before Maturity Step 4. Calculate the proceeds. Step 3. Calculate the bank discount. Step 2. Calculate the discount period (time the bank holds note). Step 1. Calculate the interest and maturity value. 17-18

Discounting an Interest-Bearing Note before Maturity Roger Company sold the following promissory note to the bank: Date of Face Value Length of Interest Bank Discount Date of Note of Note Note Rate Rate Discount March 8 $2,000 185 days 6% 5% August 9 17-19 11-19

Discounting an Interest-Bearing Note before Maturity Roger Company sold the following promissory note to the bank: Date of Face Value Length of Interest Bank discount Date of Note of Note Note Rate Rate Discount March 8 $2,000 185 days 6% 5% August 9 I = $2,000 x .06 x 185 = $61.67 360 What are Roger’s interest and maturity value? MV = $2,000 + $61.67 = $2,061.67 What are the discount period and bank discount? $2,061.67 x .05 x 31 = $8.80 360 What are the proceeds? Calculation on next slide $2,061.67 – $8.80 = $2,052.87 17-20 11-20

Calculation of days without table Manual Calculation March 31 -- 8 23 April 30 May 31 June 30 July 31 August 9 154 Table Calculation August 9 221 days March 8 -- 67 days Days passed before note is discounted 154 Length of note 185 -- 154 Discount period 31 185 days -- length of note -- 154 days Roger held note 31 days bank waits 17-21