Chapter 11
Promissory Notes, Simple
Discount Notes, and
The Discount Process
McGraw-Hill/Irwin
©2008 The McGraw-Hill Companies, All Rights Reserved
#11
Promissory Notes, Simple Discount
Notes, and the Discount Process
Learning Unit Objectives
Discounting and Interest-bearing Note
LU11.2
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
11-2
Promissory Notes, Simple Discount
Notes, and the Discount Process
#11
Learning Unit Objectives
Structure
of
Promissory
Notes;
the
LU11.1
Simple Discount Note
11-3
•
Differentiate between interest-bearing and noninterestbearing 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
Structure of a Promissory Note
Figure 11.1
$10,000
___________a.
LAWTON, OKLAHOMA
October 2, 2007
______________________c.
__________________________b.
AFTER DATE _______
PROMISE TO PAY TO
Sixty days
We
G.J. Equipment Company
THE ORDER OF ___________________________________________d.
____________________________________________DOLLARS
Ten Thousand and 00/100 ------PAYABLE AT ____________________________________
Able National Bank
9%
VALUE RECEIVED WITH INTEREST AT ______e.
REGAL CORPORATION f.
NO. ______
114
________________
J.M. Moore
DUE _____________________g.
December 1, 2007
TREASURER
a. Face value
b. Time
c. Date
11-4
d. Payee
e. Rate
f. Maker
g. Maturity date
Simple Discount Note
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
Bank discount rate - the
percent of interest
11-5
Proceeds - the amount the
borrower receives after the bank
deducts its discount from the
loans maturity value
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 0.10 x 90 = $250
360
Bank Discount
Bank Discount
Rate
$10,000 - $250 = $9,750
Proceeds
The actual amount the borrower receives after paying
the discount to the bank.
11-6
Comparison of Simple Interest Note vs Simple
Discount Note
Simple Interest Note - Ch. 10
Simple Discount Note - Ch. 11
Interest
I = Face Value (Principal) x R x T
I = $14,000 x .08 x 60
360
I = $187.67
Maturity Value
MV = Face Value + Interest
MV = $14,000 + $ 187.67=$14,187.67
Interest
I = Face Value (Principal) x R x T
I = $14,000 x .08 x 60
360
I = $186.67
Maturity Value
MV = $14,000
Proceeds
Proceeds = Face Value
Proceeds = $14,000
Proceeds
Proceeds = MV - Bank discount
Proceeds = $14,000 – 186.67
Proceeds = $13,813.33
11-7
Comparison - Effective Rate
Simple Interest Note - Ch. 10
Rate =
Interest
Proceeds x Time
Rate =
$186.67
$14,000 x 60
360
Rate = 8%
Simple Discount Note - Ch. 11
Rate =
Interest
Proceeds x Time
Rate =
$186.67
$13,813.33 x 60
360
Rate = 8.11%
The effective rate for a simple discount note is
higher than the stated rate, since the bank
calculated the rate on the face of the note and not
on what Terrance received
11-8
Table 11.1 - Comparison of simple interest
note and simple discount note
Simple interest note (Chapter 10)
Simple discount note (Chapter 11)
1. A promissory note for a loan with a term of usually
less than 1 year. Example: 60 days
1. A promissory note for a loan with a term of usually
less than 1 year. Example: 60 days
2. Paid back by one payment at maturity. Face value
equals actual amount (or principal) of loan (this is not
maturity value)
2. Paid back by one payment at maturity. Face value
equals maturity value (what will be repaid)
3. Interest computed on face value or what is actually
borrowed. Example: $186.67
3. Interest computed on maturity value or what will be
repaid and not on actual amount borrowed. Example:
$186.67
4. Maturity value = Face value + Interest
Example: $14, 186.67
4. Maturity value = Face value
Example: $14, 000
5. Borrower receives the face value
Example: $14,000
5. Borrower receives proceeds = Face value - bank
discount. Example: $13,813.33
6. Effective rate (true rate is same as rate stated on
note). Example: 8%
6. Effective rate is higher since interest was deducted
in advance. Example: 8.11%
7. Used frequently instead of the simple discount note.
Example: 8%
7. Not used as much now because in 1969
congressional legislation required that the true rate of
interest be revealed. Still used where legislation does
not apply, such as personal loans.
11-9
Practice
Non-interest bearing note of $12,000.
Simple discount rate of 9.5%
60-day note.
1.
2.
3.
4.
11-10
What is the maturity value?
What is the bank discount?
What is the proceeds to the borrower?
What is the effective rate? Is it 9.5%?
Key to Practice
Non-interest bearing note of $12,000.
Simple discount rate of 9.5%
60-day note.
Maturity value = Face value = $12,000
Bank discount = Maturity value x Bank discount rate x Time
Bank discount = 12,000 x 0.095 x 60/360 = $190
Proceeds = Maturity value – Bank discount
Proceeds = $12,000 - $190 = $11,810
11-11
Effective rate = Interest
$190
_________________ = ____________ =9.65%
Proceeds x Time/
11,810 x 60/360
Treasury Bills
Loan to Federal Govt.
Terms of Purchase
91 days (13 Weeks)
or
1 Year
If you buy a $10,000
13 week Treasury
bill at 8%, how
much will you pay
and what is the
effective rate?
11-12
$10,000 x .08 x 13 = $200
52
Cost to buy = $10,000 - $200 = $9,800
Effective Rate =
$200 = 8.16%
$9,800 x 13
52
Problem 11-13:
Solution:
Treasury bill $10,000 at 5% rate;
13-week Treasury bill.
$10,000 x 0.05 x 13 = $125
52
Interest earned
Actual cost to pay for Treasury bill = 10,000 – 125 = $9,875
Effective rate =
11-13
$125 _ = 5.06%
$9,875 x 13
52
Practice
Solution:
Treasury bill for $10,000 for 13 weeks;
Discount value in buying bill = $23.90
Find the effective rate of Treasury bill.
$23.90 _
$23.90
=
= .95829% = .96%
13
$2,494.025
$9,976.10 x
52
($10,000.00 - $23.90) = $9,976.10 (Actual cost to buy
Treasury bill)
$10,000.00 - $9,976.10
11-14
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
11-15
Discounting an Interest-Bearing
Note before Maturity
Camille Wilson sold the following promissory note to the bank:
Date of
note
March 8
Face Value
of note
$2,000
Length of
note
185 days
Date of
note
Interest
rate
10%
Bank Discount Date of
rate
discount
9%
August 9
Date of
discount
Date
note due
31 days
154 days before note is discounted
March 8
Bank waits
August 9
185 days total length of note
11-16
Sept. 9
Discounting an Interest-Bearing
Note before Maturity
Camille Wilson 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
10%
Bank Discount Date of
rate
discount
9%
August 9
What are Camille’s interest and maturity value? What are the
discount period and bank discount? What are the proceeds?
I = $2,000 x0 .10 x 185 = $102.78
360
$2,102.78 x 0.09 x 31 = 16.30
360
MV = $2,000 + $102.780 = $2,102.78
$2102.78 – 16.30 = $2,068.48
Calculation
on next slide
11-17
Calculation of days without table
Manual Calculation
Table Calculation
March
August 9
March 8
31
-8
23
April
May
June
30
31
30
July
August
31
9
154
11-18
221 days
-67 days
154 days passed
before note is discounted
185 day note
-154
31 discount pd.
185 days - length of note
-154 days Camille held note
31 days bank waits
Problem 11-14:
Solution:
May 8: $3,000, 8%, 180-day note
August 16: Discounted at bank at 9% discount
rate
Bank Discount
Aug. 16 228 days
May 8 -128
100 days passed
$3,120.00 x .09 x
80
=62.40
360
180 – 100 = 80 days
$3,120.00 (MV)
(discount period)
- 62.40 (Bank discount)
$3,057.60 proceeds
180
$3,000 x .08 x 360 = $120
$3,000 + $120 = $3,120
(Maturity Value)
11-19
Problem 11-15:
Solution:
Oct 11
Aug 8
August 8: $8,000, 8%, 120-day note
Oct 11: discounted at bank at 9%
284 days
- 220
64 days passed
120 – 64 = 56 days
(discount period)
$5,000 x .08 x 120 = $133.33
Interest earned on original note
360
$5,000 + $133.33 = $5,133.33 Maturity Value
Bank discount= $5,133.33 x 0.09 x 56/360 = $71.87
Proceeds = $5,133.33 – 71.87 = $5,061.46
11-20
Homework
• 11-1
• 11-4
• 11-6
• 11-10
• 11-16
11-21