LESSON 5 SIMPLE DISCOUNT NOTE

Learning Outcomes By the end of this lesson, students should be able to: Define the basic terms used with simple discount note. Differentiate between simple interest and simple discount note. Calculate the bank discount and proceeds. Find the face value. Understand the concept of discounting a note. Find the proceeds when discounting a simple interest note

List of Topics Simple discount note. Differences between simple interest and simple discount note. Calculate the bank discount and proceeds. Find the face value. Understand the concept of discounting a note. Find the proceeds when discounting a simple interest note

Simple discount note The total amount due at the end of the loan, or the maturity value is the sum of the face value (principal) and interest. Some banks deduct the loan interest in advance from the face value. The borrower will not receive the face value on these types of notes, but will only receive face value less interest, which is called the proceeds. When banks do this, the note is called a simple discount note. The interest charged is called bank discount.

Contd… Formula to calculate bank discount: B =MDT Where, B – Bank discount (interest taken in advance) M – Maturity value (Face value of the simple discount note / Amount to be repaid at the end of a loan period) D – Discount rate (interest rate for interest taken in advance) T – Time in the loan period (in years)

Contd… Formula to calculate the proceeds. P =M-B Where, P - Proceeds (Amount received by the borrower for each note) M – Maturity value (Face Value of the simple discount note) B – Bank discount

Contd…. Formula to calculate Maturity value and interest of the simple interest note. Simple interest is found by using the formula M = P +I and I =PRT Where: M – Maturity value I – Interest, the amount charged or earned for any loan or deposits. P – Principal, either the loan amount or the amount invested. R – Interest rate T – Time of the loan period (in years)

Example If two notes exist: One is a 60-day note for RM20,000 discounted at 9%, and the other is a 60-day note for RM20,000 with a 9% simple interest rate. Find the following: Interest owed. Proceeds. Maturity value.

Simple discount note Simple Interest Note Interest Proceeds Maturity Value Maturity value

Discounting a Simple Interest Note before Maturity The process of discounting a simple interest note before maturity involves a three-party arrangement, such as manufacturer, retailer and bank. For example, a manufacturer delivered furniture to a retailer in March, 2011. The manufacturer did not request cash payment from the retailer immediately. The payment for the furniture is due in September.

In return, the manufacturer accept simple interest note to affirm the debt. However, the manufacturer will have its money tied up in this furniture until September. If the manufacturer needs cash sooner than September, the manufacturer will have to sell the note to a bank before it matures. The manufacturer is discounting the note before it matures

The bank will buy the note at a discounted price by charging some fee called bank discount. The bank gives the maturity value of the notes minus a fee charged by the bank for the service. The actual amount received by the manufacturer is called proceeds. The bank will received the full maturity value from the retailer when it is due in September

Steps for discounting simple interest note The steps involved for discounting a simple interest note are as follows: Find the maturity value of the original note. Find the discount period. Find the discount. Find the proceeds.

Example Anis Holdings received a RM 10,200, 7.5%, 200-day promissory note dated June 15 from a retailer. The note was discounted on October 22 at a national bank. The bank discount rate was 11%. Calculate: The maturity value of the simple interest note. The discount period. The bank discount. The proceeds.

Maturity value

The discount period To calculate discount period, first, we need to know the maturity date of the note. The maturity date of the note is found as: Day 166 (June 15) + 165 days = 331 (27 November) Discount period is the time from the day the note is sold (October 22) to the maturity date of the loan (27 November). November 27 331 October 22 -295 =36 days The discount period is 36 days

The bank discount The discount is computed by using the discount period of 36 days and the 11% discount rate.

The proceeds Proceeds are the amount of money received by Anis Holdings from the bank. P =M –B RM 10,625 –RM 116.88 = RM10,508.13

Lesson Summary This topic explains the discount note and its calculation. Students would be able to compute a discount note and the proceeds if discount notes cases are presented its maturity. The next topic would cover the lesson on compound interest. The interest charged is compounded over the length of the loan period, thereby making it grow bigger than simple interest.