Chapter 11

Promissory Notes, Simple

Discount Notes, and
The Discount Process

McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved

 Promissory Notes, Simple Discount
#11 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
#11 Notes, and the Discount Process

Learning Unit Objectives

LU11.1
Structure of Promissory Notes; the
Simple Discount Note
• Differentiate between interest-bearing and noninterest-
bearing 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
11-3
 Structure of a Promissory Note
Figure 11.1

$10,000
___________a. LAWTON, OKLAHOMA October 2, 2007
______________________c.
__________________________b.
Sixty days AFTER DATE _______
We PROMISE TO PAY TO
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 DUE _____________________g.
December 1, 2007 ________________
J.M. Moore
TREASURER

a. Face value d. Payee g. Maturity date

b. Time e. Rate
c. Date f. Maker
11-4
 Simple Discount Note

Simple discount note - A note in Bank discount - the interest that

which the loan interest is banks deduct in advance
deducted in advance

Maturity Value – The total

amount due at the end of the loan

Proceeds - the amount the

Bank discount rate - the borrower receives after the bank
percent of interest deducts its discount from the
loans maturity value

11-5
 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

11-6
 Comparison

Simple Interest Note - Ch. 10 Simple Discount Note - Ch. 11

Interest Interest
I = Face Value (Principal) x R x T I = Face Value (Principal) x R x T
I = $14,000 x .08 x 60 I = $14,000
$10,000 x .08
.10 x 60
90
360 360
I = $187.67 I = $186.67
$250
Maturity Value Maturity Value
MV = Face Value + Interest MV = $14,000
MV = $14,000 + $ 187.67=$14,187.67
Proceeds Proceeds
Proceeds = Face Value Proceeds = MV - Bank discount
Proceeds = $14,000 Proceeds = $14,000
$10,000 - $186.67
$250
Proceeds = $13,813.33
$9,750

11-7
 Comparison - Effective Rate

Simple Interest Note - Ch. 10 Simple Discount Note - Ch. 11

Rate = Interest Rate = Interest
Proceeds x Time Proceeds x Time
Rate = $186.67 Rate = $186.67
$14,000 x 60 $13,813.33 x 60
360 360
Rate = 8% 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 1. A promissory note for a loan with a term of usually
less than 1 year. Example: 60 days less than 1 year. Example: 60 days
2. Paid back by one payment at maturity. Face value 2. Paid back by one payment at maturity. Face value
equals actual amount (or principal) of loan (this is not equals maturity value (what will be repaid)
maturity value)
3. Interest computed on maturity value or what will be
3. Interest computed on face value or what is actually repaid and not on actual amount borrowed. Example:
borrowed. Example: $186.67 $186.67
4. Maturity value = Face value + Interest 4. Maturity value = Face value
Example: $14, 186.67 Example: $14, 000
5. Borrower receives the face value 5. Borrower receives proceeds = Face value - bank
Example: $14,000 discount. Example: $13,813.33
6. Effective rate (true rate is same as rate stated on 6. Effective rate is higher since interest was deducted
note). Example: 8% in advance. Example: 8.11%
7. Used frequently instead of the simple discount note. 7. Not used as much now because in 1969
Example: 8% congressional legislation required that the true rate of
interest be revealed. Still used where legislation does
not apply, such as personal loans.

11-9
 Treasury Bills
Loan to Federal Govt.
Terms of Purchase
91 days (13 Weeks)
or
1 Year

If you buy a $10,000 $10,000 x .08 x 13 = $200

13 week Treasury 52
bill at 8%, how Cost = $10,000 - $200 = $9,800
much will you pay
and what is the Effective Rate = $200 = 8.16%
effective rate? $9,800 x 13
52
11-10
 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

11-11
 Discounting an Interest-Bearing
Note before Maturity
Camille Wilson sold the following promissory note to the bank:
Date of Face Value Length of Interest Bank Discount Date of
note of note note rate rate discount
March 8 $2,000 185 days 10% 9%

Date of Date of Date

note discount note due
31 days

154 days before note is discounted Bank waits

March 8 August 9 Sept. 9
185 days total length of note

11-12
 Discounting an Interest-Bearing
Note before Maturity

Camille Wilson sold the following promissory note to the bank:

Date of Face Value Length of Interest Bank Discount Date of
note of note note rate rate discount
March 8 $2,000 185 days 10% 9%

What are Camille’s interest and maturity value? What are the
discount period and bank discount? What are the proceeds?
I = $2,000 x .10 x 185 = $102.78
360
MV = $2,000 + $102.780 = $2,102.78
$2,102.78 x .09 x 31 = 16.30
360 $2102.78 – 16.30 = $2,068.48
Calculation
on next slide
11-13
 Calculation of days without table
Manual Calculation Table Calculation
March 31 August 9 221 days
-8 March 8 -67 days
23 154 days passed
before note is discounted
April 30
185 day note
May 31
-154
June 30 31 discount pd.
July 31
August 9 185 days - length of note
154 -154 days Camille held note
116 days bank waits
11-14
 Problem 11-10:

Solution:
$23.90 _ $23.90
= = .95829% = .96%
$9,976.10 x 13 $2,494.025
52

($10,000.00 - $23.90) = $9,976.10

$10,000.00 - $9,976.10

11-15
 Problem 11-13:
Solution:
$10,000 x .05 x 13 = $125
52

Effective rate = $125 _ = 5.06%

$9,875 x 13
52

11-16
 Problem 11-14:

Solution:
Bank Discount
Aug. 16 228 days
May 8 -128 80
100 days passed $3,120.00 x .09 x =
360
$3,120.00
180 – 100 = 80 days - 62.40
(discount period)
$3,057.60 proceeds
180
$3,000 x .08 x 360 = $120
$3,000 + $120 = $3,120 MV

11-17
 Problem 11-16:

Solution:
Oct 11 284 days
Aug 8 - 220
64 days passed
120 – 64 = 56 days
(discount period)

$5,000 x .08 x 120 = $133.33

360

$5,000 + $133.33 = $5,133.33 Maturity Value

11-18