BANK DISCOUNT
Another way of lending money is to collect the interest in advance. This interest is referred to as bank
discount. A bank discount is an interest computed on the maturity value of the loan and is deducted from
that amount at loan date to determine the net amount to be received by the borrower. Simply stated, the
amount of loan applied for at loan date is the maturity value of the loan. The bank discount is deducted
from that amount to arrive at the proceeds—the amount the borrower is to receive. This is in contrast to
simple interest, which is altogether paid with the principal at maturity date.
In computing for the bank discount, three factors are being considered: maturity value, bank discount
rate and time. In this section, bank discount rate is referred to as discount rate or rate and bank discount
as discount.
Illustration: Mirasol availed of a P245,000 loan at 14% discount rate for 9 months. Find the bank discount
and proceeds of the loan. Bank discount is the product of the maturity value, discount rate and time; or
stated as a formula,
Bank Discount = Maturity Value x discount rate x time
BD = MV x R x T
The maturity value is the amount applied for by the borrower on loan date. This is the same amount that
the debtor is supposed to pay at maturity date. In the illustration, the maturity value is P245,000.
The bank discount rate, expressed as a percentage, is converted to a decimal for computation purposes.
Unless otherwise stated, the bank discount rate is an annual rate. In the illustration, the rate is 14% or in
decimal form, .14.
The time expressed in years or fractional part of a year, is the period between the loan and maturity date.
In the example, time is 9 months or 9/12 or as a decimal, .75.
Finding the bank discount
The bank discount may now be computed using bank discount formula. Substituting the givens in the
illustration,
BD = MV x R x Time
BD = 245,000 x .41 x .75
BD = Php 25,725
Thus, a loan of P245,000 for one year at a bank discount rate of 14% will cost Mirasol '25,725 in discount.
Finding the proceeds
On loan date, Mirasol did not the entire P245,000. The bank discount of P25,725 had to be deducted as
interest in advance. The proceeds formula follows,
Proceeds = Maturity Value – Bank Discount
P = 245,000 – 25,725
P = Php 219,275
Hence, on loan date, Mirasol received P219,275 as proceeds of her loan.
Promissory Notes
In the previous sections, computations involving simple interest and bank discount on loans were
discussed. In actual cases, when a business or person obtains a loan. he signs a note evidencing his
indebtedness and commitment to pay. 'this is actually a promissory note.
A promissory note is an unconditional promise in writing made by one person to
another, signed by the maker, engaging to pay on demand, or at a fixed or determinable future time, a
sum certain in money to order or to bearer (Negotiable Instruments Law).
This document stating the details of a loan is a negotiable instrument which, when properly endorsed, can
be transferred or sold to another person or a bank which is not a party to the original loan.
Originally, there are two parties to a promissory note—the maker who makes the promise and who signs
the instrument and the payee to whom the promise is made and to whom the instrument is payable.
Types of Notes
Promissory notes may either be interest-bearing or non-interest-bearing. Generally, there are two types
of promissory notes—the simple interest note and the bank discount note. In this section, the
computational concepts learned in the previous sections may be related as each type of note is analyzed.
Simple Interest Note
Illustration: On May 13, 2012, Thaddeus Dominique applies for a loan at Domane Credit Union. The loan
was approved for PI 75,000, at 12% simple interest, for 90 days. The parts of the simple interest note are
discussed and identified as follows:
Maker. Thaddeus Dominique. The maker is the person or business borrowing the money.
Payee. Domane Credit Union. The payee is the person or business lending the money.
Face Value. P 175,000. The face value of the note is the principal amount borrowed.
Simple Interest Rate. 12%. The annual rate of interest charged.
Term. 90 days. The time period of the note.
Issue Date. May 13, 2012. The date when the note was signed and issued.
Maturity Date. Aug. 11, 2012. The date when maturity value is due the payee.
Thus, the simple interest on the note, may be computed by substituting the face value to the principal in
the simple interest formula I = PRT, hence it becomes I = F V x R
I = Face Value x Rate x Time
I = 175,000 x .12 x 90/360
I = Php 5,250
The maturity Value is the computed as ,
MV = FV + Interest
MV = 1750,000 + 5,250
MV = Php 180, 250
Bank Discount Note
Illustration: On June 13, 2012, Theodore Daniel was granted a loan by Basic Enterprises for P225,000,
payable in 75 days at 8% bank discount.
The parts of the bank discount note are discussed and identified as follows:
Maker. Theodore Daniel. The maker is the person or business borrowing the money.
Payee. Basic Enterprises. The payee is the person or business lending the money
Face Value. P225,000. The face value of the note is the maturity value of the loan.
Bank Discount Rate. 8%. The annual rate of interest charged.
Term. 75 days. The time period of the note.
Issue Date. June 13, 2012. The date when the note was signed and issued.
Maturity Date. Aug. 27, 2012. The date when maturity value is due the payee
Thus, the bank discount on the note may be computed by substituting the face value to the maturity value
in the bank discount formula BD = MV x R x T, hence it becomes
BD = Face value x Discount rate x Time
BD = 225,000 x .08 x 75/360
BD = Php 3,750
Solving for the proceeds,
Proceeds = Face Value – Bank discount
Proceeds = 225, 000 – 3,750
Proceeds = Php 221,250
Hence, on loan date, Theodore Daniel received P221 ,250 as proceeds of the loan and is to pay P225,000—
the face value of the note at maturity date.
Note that in a simple interest note the face value of the note is equal to the principal. Hence, the maturity
value is higher than the face value. On the other hand, in a bank discount note, the face value of the note
is the maturity value. Thus, the borrower pays for the face value at maturity date. A non-interest-bearing
note generally looks similar to an interest-bearing note except that a non-interest-bearing note does not
make reference to an interest rate.