Promissory Note
A promissory note is a written promise by one party to pay
a certain sum of money, with or without interest, at a
specific date or on demand, to another party.
Chapter 8
Simple Interest Applications
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Terminology of Promissory Notes
Terminology of Promissory Notes
(continued)
• maker - party making promise to pay
• payee - party to whom the promise to pay
is made
• face value - sum of money (principal)
specified
• rate of interest - stated as a simple annual
rate based on the face value
(continued)
• issue date - date on which the note was
made
• term of the note - length of time before
the note matures (becomes payable)
• due date or date of maturity - date on
which the note is paid
• interest period - time period from the
date of issue to the legal due date
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Promissory Notes
Legal Due Date
• The amount of interest is payable together
with the face value on the legal due date.
• The maturity value is the amount payable
on the due date (face value plus interest).
• Canadian law adds three days of grace to
the term of the note to obtain the legal due
date (Bills of Exchange Act, Section 41)
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Maturity Value of Interest-bearing
Promissory Note
Legal Due Date
• Interest is paid for the three days of
grace.
• No late payment penalty.
• Credit rating remains good.
• Write “No Grace Days” on note if you
decide not to include the three days of
grace.
• The legal due date allows for cases in
which repayment date falls on a
statutory holiday.
S = P(1 + rt)
S Maturity value
P Face value of note
r Rate of interest on note
t
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Interest period (number of days between
date of issue and legal due date)
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Finding the Maturity Value of an
Interest-bearing Promissory Note
Exercise 8.2 A #2, 4 p. 298
Compute the maturity value of a 90 day note
with a face value of $1000 issued on April 21,
2005 at an interest rate of 5.5%.
P = 1000, r = 0.055, t = 90 + 3 days of grace
S=P(1+rt) = 1000((1+.055(93)) =1014
365
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Present Value of Promissory Note
S
P= S
1 + rt
Face value ( or present value) of note at
issue date
Maturity value
r
Rate of interest
P
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Finding the Present Value of a Note
A promissory note has a maturity value of
$1258.25 and bears an annual interest rate of
8%. If you include the three days of grace,
there are 93 days in the interest period. Find
the face value or present value of the note.
P= S
1+rt
t Interest period
11
=
1258.25 = 1233.11
1+.08(93)
365
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Exercise 8.3 A #1, 2 p. 305
Present Value of a Promissory Note
• The present value is the value of the note
any time before the due date.
• The present value depends on the rate
money is worth, the time between the
present date and date of maturity, and the
maturity value.
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Finding the Present Value of an
Interest-bearing Note
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Finding the Present Value of an
Interest-bearing Note
• Step 1 -- Find the maturity value of the
note using the stated interest rate.
A sixty-day note for $10,000 bears an annual
interest rate of 10%. Compute the present
value on the date of issue if money is worth
6%. The note matures in 63 days taking the 3
days of grace into consideration.
• Step 2 -- Calculate the present value of
the note using the rate money is worth.
Step 1 -- S = 10000(1+.10(63)) = 10,172.60
365
(continued)
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Finding Present Value
Exercise 8.3 B #4 p. 305
(continued)
Step 2 --Find present value using the issue
date as the focal date. Three days of grace
have been added to the 60 days.
P = S = 10172.60 = 10,068.33
1+rt
1+.06(63)
365
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Canadian Treasury Bills
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Purchasing a T-bill
• The T-bill is purchased at a discounted
price reflecting a rate of return
determined by current market
conditions.
• The discounted price is determined by
finding the present value (P) of the Tbill.
• The issuing government guarantees the
payment of face value at maturity.
• Promissory notes issued by the federal
government and most provincial
governments to meet short-term
financing needs.
• Terms of 91, 182, and 364 days.
• Do not carry an interest rate.
• No days of grace.
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Calculating the Purchase Price of a
T-bill
Exercise 8.3 C #6 p. 306
An investment dealer bought a 182-day
Canadian T-bill with a face value of $100,000
to yield an annual return of 2.33%. Find the
purchase price.
Present Value = P = 100000
= 98,851.53
1+.0233(182)
365
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Exercise 8.3 C #6 Cont.
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Demand Loans
• The lender may demand payment of the
loan in full or in part at any time.
• The borrower may repay all of the loan
or any part at any time without penalty.
• Interest, based on the unpaid balance,
is usually payable monthly.
• Interest rate is not fixed.
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Demand Loan
Paying Off a Demand Loan (continued)
A $1200 demand loan is paid off in four
monthly payments of $300 each. In addition,
interest is charged at 6% per annum or .005
per month. The interest is calculated on the
unpaid balance using the formula:
I = Prt.
The first month’s interest is 1200(.06)(1) = $6
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(continued)
Month
Amount Owed
Interest
1
1200
6.00
2
900
4.50
3
600
3.00
4
300
1.50
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Exercise 8.4 A #2 p. 310
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Declining Balance Method
• A demand loan may be paid off by a
series of partial payments.
• Each partial payment is first applied to
the accumulated interest.
• Any remainder is used to reduce the
outstanding principal.
• Interest is always calculated on the
unpaid balance.
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Pointers and Pitfalls
Blended Payments
• The periodic payment is constant.
• The payment is first applied to the
accumulated interest.
• The remainder of the payment after the
interest has been paid is used to reduce
the unpaid principal.
• The last payment may be different.
• The date on which there is a change in
the interest rate is counted as the first
day at the new interest rate.
• The date on which a partial payment is
made is counted as the first day at the
new outstanding principal balance.
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Homework #8
Exercise 8.4 B #4 p. 311
• Exercise 8.2: #A1, A3.
• Exercise 8.3: #A1, A2, B3, C5.
• Exercise 8.4: #A1, B3.
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