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

#11

Promissory Notes, Simple Discount

Notes, and the Discount Process

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 ------Able National Bank
PAYABLE AT ____________________________________
9%
VALUE RECEIVED WITH INTEREST AT ______e.

REGAL CORPORATION f.

114
NO. ______

J.M. Moore
________________

December 1, 2007
DUE _____________________g.

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
The actual amount the borrower receives after paying
the discount to the bank.
11-6

Proceeds

Comparison of Simple Interest Note vs Simple

Discount Note
Simple Interest Note - Ch. 10
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
Proceeds
Proceeds = Face Value
Proceeds = $14,000

11-7

Simple Discount Note - Ch. 11

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 = MV - Bank discount
Proceeds = $14,000 186.67
Proceeds = $13,813.33

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.What is the maturity value?
2.What is the bank discount?
3.What is the proceeds to the borrower?
4.What is the effective rate? Is it 9.5%?

11-10

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

Interest earned
52
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%
$9,976.10 x 13
$2,494.025
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

Bank Discount Date of

rate
discount
10%
9%
Augu

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

Bank Discount Date of

rate
discount
10%
9%
Augu

What are Camilles 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

30

May

31

June

30

July

31

August

9
154

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

11-18

Problem 11-14:
Solution:

May 8: $3,000, 8%, 180-day note

August 16: Discounted at bank at 9% discount
rate

Aug. 16 228 days

May 8 -128
100 days passed

Bank Discount
80
$3,120.00 x .09 x 360=62.40

180 100 = 80 days

$3,120.00 (MV)
(discount period)
- 62.40 (Bank discount)
$3,000 x .08 x 180 = $120 $3,057.60 proceeds
360
$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