Chapter Seventeen

PROMISSORY NOTES, SIMPLE DISCOUNT

NOTES, AND THE DISCOUNT PROCESS

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

LEARNING UNIT OBJECTIVES

17-2

LU 17-1: Structure of Promissory Notes; the Simple Discount Note

1. Differentiate between interest-bearing and non-interest-bearing notes.

2. Calculate bank discount and proceeds for simple discount notes.

3. Calculate and compare the interest, maturity value, proceeds, and effective rate of a simple interest note with a simple discount note.

4. Explain and calculate the effective rate for a Treasury bill.LU 17-2: Finding the Face Value, Rate, and Time for a Simple Interest Note and a Simple Discount Note

1. Find the face value (principal), rate, and time of a simple interest note.

2. Find the face value (maturity value), bank discount rate, and time of a simple discount note.

LEARNING UNIT OBJECTIVES

LU 17-3: Discounting an Interest-Bearing Note before Maturity1. Calculate the maturity value, bank discount, and proceeds

of discounting an interest-bearing note before maturity.2. Identify and complete the four steps of the discounting

process.

17-3

STRUCTURE OF A PROMISSORY NOTE

17-4

SIMPLE DISCOUNT NOTE TERMINOLOGY

17-5

Simple Discount Note -- A note in which the loan interest is deducted in advance.

Bank Discount -- The interest that banks deduct in advance.

Bank Discount Rate -- The percent of interest.

Proceeds -- The amount the borrower receives after the bank deducts its discount from the loan’s maturity value.

Maturity Value – The total amount due at the end of the loan (the sum of the face value, or principal, and interest).

SIMPLE DISCOUNT NOTE

17-6

Pete Runnels has a choice of two different notes that both have a face value (principal) of $14,000 for 60 days. One note has a simple interest rate of 8%, while the other note has a simple discount rate of 8%. For each type of note, calculate (a) interest owed, (b) maturity value, (c) proceeds, and (d) effective rate:

(See next slide for solutions)

COMPARISON OF SIMPLE INTEREST NOTE AND SIMPLE

DISCOUNT NOTE

17-7

Scenario

Face value = $14,000

Interest rate = 8%

60 days

COMPARISON OF SIMPLE INTEREST NOTE AND SIMPLE

DISCOUNT NOTE

17-8

13 52

TREASURY BILLS

17-9

Terms of Purchase: 28 days (4 weeks), 91 days (13 weeks), or 1 Yr.

Example: If you buy a $10,000, 13-week Treasury bill at 8%, how much will you pay, and what is the effective rate?

$10,000 x .08 x

= $200

Cost = $10,000 -- $200 = $9,800

Effective rate = $200 = 8.16% $9,800 x 13

52

Purchase Price (proceeds) of a Treasury Bill = The value of the Treasury bill - the discount.

A Treasury bill is a loan to the federal government

FINDING THE FACE VALUE, RATE, AND TIME FOR A SIMPLE

INTEREST NOTEMaturity Value Formula (Chapter 16)

M = P(1 + RT)Averi Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value (P) and interest (I) for the simple interest note.

P = M 1 + RT

= 2,5501 + (.06 X 150/360)

17-10

= 2,5501,025

P

= $2,487.80P

FINDING THE FACE VALUE, RATE, AND TIME FOR A SIMPLE

INTEREST NOTEAveri Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value (P) and interest (I) for the simple interest note.

17-11

I = M - PI = $2,250 - $2,487.80

I = $62.20

Maturity Value Formula (Chapter 16)

M = P + I

FINDING RATE

17-12

R = I PT

Averi Walker paid off a 150-day note at 6% with a single payment, also known as a balloon payment, of $2,250. Find the face value and interest for the simple interest note.

R = $62.20$2,487.50 X

150/360R = $62.20

$1,036.46

R = .06

FINDING TIME (IN DAYS)

T (in days) = I PT

X 360

T = $62.20 $2,487.80 x .06

X 360

T = $62.20 $149.27

X 360

T = 150.01 days (off due to rounding)

17-13

FINDING THE FACE VALUE, RATE, AND TIME FOR A SIMPLE

DISCOUNT NOTEAveri Walker borrowed $2,250 at 6% for 150-days to pay off a personal loan. Find the proceeds and interest for the simple discount note.

17-14

Pr = M(1 – DT)

Pr= $2,550 [1 - .06 (150/360)]

Pr = $2,550 (1 - .025)

Pr = $2,486.25 (proceeds)

B = M - Pr

B = $2,550 – $2,486.25B = $63.75 (bank discount)

FINDING RATE

D = B

――

MT

D = $62.20 $2,487.80 X 150/360

D = $62.20 $1,036.59

D = .06

17-15

FINDING TIME (IN DAYS)

T (in days) = B MD

X 360

X 360T = $62.20 $2,487.80 X .06

T = $62.20 $149.27

T = 4167 x 360 = 150 days

17-16

FINDING FACE VALUE FOR DESIRED PROCEEDS

17-17

M = Pr

1 - DT

Mallori Rouse needs $3,000 to drywall her master bedroom. Find the face value of a simple discount note that will provide her with $3,000 at 6.5 % for 85 days.

M = $3,000.00 (1 - .065 x 85/360)

M = $3,046.76

M = $3,000 .984752778

DISCOUNTING AN INTEREST-BEARING

NOTE BEFORE MATURITY

17-18

Step 1. Calculate the interest and maturity value.

Step 2. Calculate the discount period (time the bank holds note).

Step 3. Calculate the bank discount.

Step 4. Calculate the proceeds.

DISCOUNTING AN INTEREST-BEARING

NOTE BEFORE MATURITY

11-19

Roger Company sold the following promissory note to the bank:

Date of Face Value Length of InterestBank Discount Date of Note of Note Note Rate Rate DiscountMarch 8 $2,000 185 days 6% 5% August 9

17-19

DISCOUNTING AN INTEREST-BEARING

NOTE BEFORE MATURITY

11-20

What are Roger’s interest and maturity value?

MV = $2,000 + $61.67 = $2,061.67

$2,061.67 x .05 x 31 = $8.80 360

$2,061.67 – $8.80 = $2,052.87

Calculation on next slide

17-20

What are the discount period and bank discount?

What are the proceeds?

I = $2,000 x .06 x 185 = $61.67 360

Roger Company sold the following promissory note to the bank:

Date of Face Value Length of InterestBank discountDate of Note of Note Note Rate Rate DiscountMarch 8 $2,000 185 days 6% 5% August 9

CALCULATION OF DAYS WITHOUT TABLE

17-21

Manual Calculation

March 31-- 8

23April 30May 31June 30July 31August 9

154

185 days -- length of note-- 154 days Roger held note 31 days bank waits

Table Calculation

August 9 221 daysMarch 8 -- 67 daysDays passed before note is discounted 154

Length of note 185-- 154

Discount period 31