GT10103

Sem 1 18/19
7. Explain four differences between a simple interest note and a simple discount note.
Which type of note would have a higher effective rate of interest? Why?
Give an example of bank discount rate equivalent to simple interest rate.
(10 marks)

Answer :

Simple Interest Note Simple Discount Note

Involve principal (face value or loan
amount), interest rate, time, interest and
maturity value
Face value is the amount loaned to the
borrower
Calculated based on principle
Face value ( Principle ) + Interest = Maturity
Value
Involve proceeds (loan amount), discount rate,
time, bank discount (interest) and face value
(maturity value)
Maturity value is the amount loaned to the
borrower
Calculated based on maturity value
Proceeds + Discounts = Face Value ( Maturity
Value )

Type of notes would have a higher effective rate of interest is simple discount note. Because,
interest from the simple discount note interest being deducted in advance verses the true rate
when it was stated on the note for the simple interest note.

Example of bank discount rate equivalent to simple interest rate :

Tae Hyung, owner of a small restaurant, goes to her bank to borrow money. He signs a 120-day
note with a $350,000 face value at a 15% discount rate. Using 360-day year, compute ;

(a) the discount amount,

(b) the proceeds of the loan,
(c) and actual discount rate.

Solution :

Here,
FV = $350,000
R = 15%
T = 120
360

(a) Discount amount = FV × R × T

= $350,000 × 0.15 × 120
360
= $17,500
 GT10103
Sem 1 18/19
(b) Proceeds = Face Value – Discount Amount
= $350,000 - $17,500
= $332,500

(c) Actual discount rate, R = ___I___

(P×T)

= _____$17,500_____
( $332,500× 120/360)

= 0.15789 or 15.79%

# The interest for Tae Hyung is actually 15.79%; the discount rate is 15%. They are different
rates, but both lead to $17,500 fee to borrow $332,500 for 120 days.