Promissory Notes, Simple Discount Notes, and The Discount Process Chapter Eleven 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 11-1: 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 11-2: 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.

Structure of a Promissory Note

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. 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.

Simple Discount Note Example: Terrance Rime borrowed $10,000 for 90 days from Webster Bank. The bank discounted the note at 10%. What proceeds does Terrance receive? $10,000 x .10 x 90 = $250 360 Bank Discount Bank Discount Rate $10,000 - $250 = $9,750 Proceeds

Comparison of simple interest note and simple discount note

Comparison of simple interest note and simple discount note Scenario Face value = $18,000 Interest rate = 8% 60 days

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: 91 days (13 weeks), or 1 year 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

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.

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 11-10

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

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