PROMISSORY NOTES, SIMPLE
DISCOUNT NOTES, AND
THE DISCOUNT PROCESS
McGraw-Hill/Irwin
Chapter Eleven
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
1.
Differentiate between interest-bearing and non-interest-bearing
notes.
2.
Calculate bank discount and proceeds for simple discount notes.
3.
Calculate and compare the interest, maturity value, proceeds, and
effective rate of a simple interest note with a simple discount note.
4.
Explain and calculate the effective rate for a Treasury bill.
LU 11-2: Discounting an Interest-Bearing Note before Maturity
1. Calculate the maturity value, bank discount, and proceeds of discounting
an interest-bearing note before maturity.
2. Identify and complete the four steps of the discounting process.
11-2
STRUCTURE OF A PROMISSORY NOTE
11-3
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.
11-4
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
11-5
COMPARISON OF SIMPLE INTEREST NOTE
AND SIMPLE DISCOUNT NOTE
11-6
COMPARISON OF SIMPLE INTEREST
NOTE AND SIMPLE DISCOUNT NOTE
Scenario
Face value =
$18,000
Interest rate = 8%
60 days
11-7
TREASURY BILLS
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?
$10,000 x .08 x 13 = $200
52
Cost = $10,000 -- $200 = $9,800
Effective rate =
$200
= 8.16%
$9,800 x 13
52
11-8
DISCOUNTING AN INTEREST-BEARING
NOTE BEFORE MATURIT Y
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.
11-9
DISCOUNTING AN INTEREST-BEARING
NOTE BEFORE MATURIT Y
Roger Company sold the following promissory note to the bank:
Date of
Note
March 8
Face Value
of Note
$2,000
Length of
Note
185 days
Interest
Rate
6%
Bank Discount
Rate
5%
Date of
Discount
August 9
11-10
11-10
DISCOUNTING AN INTEREST-BEARING
NOTE BEFORE MATURIT Y
Roger Company sold the following promissory note to the bank:
Date of
Note
March 8
Face Value
of Note
$2,000
Length of
Note
185 days
Interest
Rate
6%
What are Roger’s interest and maturity value?
Bank Discount
Rate
5%
Date of
Discount
August 9
I = $2,000 x .06 x 185 = $61.67
360
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?
$2,061.67 – $8.80 = $2,052.87
Calculation
on next
slide
11-11
CALCULATION OF DAYS WITHOUT TABLE
Manual Calculation
Table Calculation
March
August 9
March 8
31
-- 8
23
30
April
May
June
July
August
31
30
31
9
154
221 days
-- 67 days
Days passed before
note is discounted
Length of note
Discount period
154
185
-- 154
31
185 days -- length of note
-- 154 days Roger held note
31 days bank waits
11-12