3 11-3 PROMISSORY NOTES To borrow money, you must find a lender (a bank or a company selling goods on credit). You must also be willing to pay for the use of the money. In Chapter 10 you learned that interest is the cost of borrowing money for periods of time. This chapter begins with a discussion of the structure of promissory notes and simple discount notes. We also look at the application of discounting with Treasury bills. The chapter concludes with an explanation of how to calculate the discounting of promissory notes. Money lenders usually require that borrowers sign a promissory note. This note states that the borrower will repay a certain sum at a fixed time in the future. The note often includes the charge for the use of the money, or the rate of interest.
20 11-20 DRILL PROBLEM 11-5 Solution: Solve for maturity value, discount period, bank discount, and proceeds (assume a bank discount rate of 9%). LU 11-2(1, 2) Face Value Rate of Length Maturity Date Date note Discount Bank (principal) Interest of Note Value of Note Discounted Period DiscountProceeds $50,000 11% 95 days June 10 July 18 Discount period = 95 – 38 = 57 July 18 199 days June 10 — 161 38 days $51,451.3957 $733.18$50,718.21 $50,000 x.11 x 95 = $1,451.39 + $50,000 = $51,451.39 MV 360 Bank discount = $51,451.39 x.09 x 57 = $733.18 360 Proceeds = $51,451.39 — 733.18 = $50,718.21
16 11-16 CALCULATION OF DAYS WITHOUT TABLE Manual Calculation March 31 — 8 23 April30 May31 June30 July31 August 9 154 185 days — length of note — 154 days Roger held note 31 days bank waits Table Calculation August 9 221 days March 8– 67 days Days passed before note is discounted154 Length of note 185 — 154 Discount period 31
2 11-2 LEARNING UNIT OBJECTIVES LU 11-1: 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 11-2: Discounting an Interest-Bearing Note before Maturity 1. 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.
21 11-21 DRILL PROBLEM 11-7 Solution: Calculate the effective rate of interest (to the nearest hundredth percent) of the following Treasury bill. Given: $10,000 Treasury bill, 4% for 13 weeks: LU 11-1(4) $10,000.00 — $100.00 = $9,900.00 Effective rate = $10,000 x.04 x 13 = $100.00 360 Effective rate = $100.00. $9,0000 x 13 52 = 4.04%
Question 4 A promissory note dated 5th July 1998 was discounted 30 days before maturity at a discount rate of 6%. The proceeds obtained was RM2487.50. i. Find the maturity value of the note. ii. If the note was kept for 10 days after 5th July 1998, when was the discount date? iii. Find the term of the note. iv. Find the face value of the note if the interest rate is 6.5%.
Question 2 Abu received a 180 day promissory note worth RM4500 at 8.5% simple interest on 14th August 1999 from Sahara. However, on 24th November 1999 Abu sold the note to a bank at the discount rate of 7.5%. i. Find the discount term. ii. Find the proceeds. iii. Find the equivalent simple interest rate that is charged by the bank.
It is a common practice by the bank to deduct charges from a loan in advance. This charges is called bank discount. Note that in bank discount it is different from the case of simple interest. In simple interest, the amount of maturity value is more than the amount borrowed. In addition, normally in the beginning you have an amount that eventually will be more after certain time period, such that the present value is lower than the future value. However, in bank discount it is the other way around. Thus, in bank discount, the amount borrowed is actually the maturity value, not the principal or the present value.
This promissory note that Chris has you sign is not just a sticky note saying that you will pay back the RM500,000 at some time in the future. This note goes into detail. It contains the terms or conditions that you will follow to pay back this large amount. It includes the interest rate that the bank charges you for borrowing money. This is how the bank makes money off of this transaction. It also includes the payment’s terms, such as when you are going to make payments and when the final payment will be made and the loan fully paid off.
This promissory note is telling you that you have 30 years to pay off this loan. If you make a payment of RM2,684.11 every month for 30 years, you will have paid off your loan at the end of 30 years. This amount includes the annual interest rate of five percent.
FAQ
When a note is non interest-bearing the maturity value equals the?
How do you find discount and proceeds?
Do trade discounts represent increases to the purchase price?
What is the equation for finding maturity value of an interest-bearing note?
