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Chapter 11

Chapter 11. Promissory Notes, Simple Discount Notes, and The Discount Process. #11. Promissory Notes, Simple Discount Notes, and the Discount Process. Learning Unit Objectives. Discounting and Interest-bearing Note before maturity. LU11.2.

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Chapter 11

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  1. Chapter 11 Promissory Notes, Simple Discount Notes, and The Discount Process

  2. #11 Promissory Notes, Simple Discount Notes, and the Discount Process Learning Unit Objectives Discounting and Interest-bearing Note before maturity LU11.2 • 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

  3. #11 Promissory Notes, Simple Discount Notes, and the Discount Process Learning Unit Objectives Structure of Promissory Notes; the Simple Discount Note LU11.1 • 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

  4. Structure of a Promissory Note Figure 11.1 ___________a. LAWTON, OKLAHOMA ______________________c. __________________________b. AFTER DATE _______ PROMISE TO PAY TO THE ORDER OF ___________________________________________d. ____________________________________________DOLLARS PAYABLE AT ____________________________________ VALUE RECEIVED WITH INTEREST AT ______e. REGAL CORPORATION f. NO. ______ DUE _____________________g. ________________ TREASURER $10,000 October 2, 2007 Sixty days We G.J. Equipment Company Ten Thousand and 00/100 ------- Able National Bank 9% 114 December 1, 2007 J.M. Moore a. Face value d. Payee g. Maturity date b. Time e. Rate c. Date f. Maker

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

  6. 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.

  7. Comparison of Simple Interest Note vs Simple Discount Note Simple Interest Note - Ch. 10 Simple Interest Note - Ch. 10 Simple Discount Note - Ch. 11 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 Interest I = Face Value (Principal) x R x T I = $14,000 x .08 x 60 360 I = $187.67 Interest I = Face Value (Principal) x R x T Interest I = Face Value (Principal) x R x T I = $14,000 x .08 x 60 360 I = $186.67 Maturity Value MV = Face Value + Interest MV = $14,000 + $ 187.67=$14,187.67 Maturity Value MV = Face Value + Interest MV = $14,000 + $ 187.67=$14,187.67 Maturity Value MV = $14,000 Maturity Value MV = $14,000 Proceeds Proceeds = Face Value Proceeds = $14,000 Proceeds Proceeds = Face Value Proceeds = $14,000 Proceeds Proceeds = MV - Bank discount Proceeds = $14,000 – 186.67 Proceeds = $13,813.33 Proceeds Proceeds = MV - Bank discount

  8. Comparison - Effective Rate Simple Interest Note - Ch. 10 Simple Discount Note - Ch. 11 Rate = Interest Proceeds x Time Rate = $186.67 $14,000 x 60 360 Rate = 8% 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

  9. Table 11.1 - Comparison of simple interest note and simple discount note Simple interest note (Chapter 10) 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) 3. Interest computed on face value or what is actually borrowed. Example: $186.67 4. Maturity value = Face value + Interest Example: $14, 186.67 5. Borrower receives the face value Example: $14,000 6. Effective rate (true rate is same as rate stated on note). Example: 8% 7. Used frequently instead of the simple discount note. Example: 8% Simple discount note (Chapter 11) 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 maturity value (what will be repaid) 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 Example: $14, 000 5. Borrower receives proceeds = Face value - bank discount. Example: $13,813.33 6. Effective rate is higher since interest was deducted in advance. Example: 8.11% 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.

  10. Practice • Non-interest bearing note of $12,000. • Simple discount rate of 9.5% • 60-day note. • 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%?

  11. 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 Effective rate = Interest $190 _________________ = ____________ =9.65% Proceeds x Time/ 11,810 x 60/360

  12. 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? $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

  13. Problem 11-13: $10,000 x 0.05 x = $125 13 52 $125 _ $9,875 x Effective rate = = 5.06% 13 52 Solution: Treasury bill $10,000 at 5% rate; 13-week Treasury bill. Interest earned Actual cost to pay for Treasury bill = 10,000 – 125 = $9,875

  14. Practice $23.90 _ $9,976.10 x $23.90 $2,494.025 ($10,000.00 - $23.90) = $9,976.10 (Actual cost to buy Treasury bill) $10,000.00 - $9,976.10 = = .95829% = .96% 13 52 Treasury bill for $10,000 for 13 weeks; Discount value in buying bill = $23.90 Find the effective rate of Treasury bill. Solution:

  15. 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

  16. 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% August 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

  17. 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% 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 MV = $2,000 + $102.780 = $2,102.78 $2,102.78 x 0.09 x 31 = 16.30 360 $2102.78 – 16.30 = $2,068.48 Calculation on next slide

  18. Calculation of days without table Manual Calculation March 31 -8 23 April 30 May 31 June 30 July 31 August 9 154 Table Calculation August 9 221 days March 8 -67days 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

  19. Problem 11-14: Bank Discount $3,120.00 x .09 x =62.40 $3,120.00 (MV) - 62.40 (Bank discount) $3,057.60 proceeds 80 360 $3,000 x .08 x = $120 $3,000 + $120 = $3,120 (Maturity Value) 180 360 May 8: $3,000, 8%, 180-day note August 16: Discounted at bank at 9% discount rate Solution: Aug. 16 228 days May 8 -128 100 days passed 180 – 100 = 80 days (discount period)

  20. Problem 11-15: $5,000 x .08 x August 8: $8,000, 8%, 120-day note Oct 11: discounted at bank at 9% Solution: Oct 11 284 days Aug 8 - 220 64 days passed 120 – 64 = 56 days (discount period) 120 360 = $133.33 Interest earned on original note $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

  21. Homework • 11-1 • 11-4 • 11-6 • 11-10 • 11-16

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