What is the 'Bank Discount Rate'

The bank discount rate is the interest rate for short-term money-market instruments like commercial paper and Treasury bills. The bank discount rate is based on the instrument's par value and the amount of the discount.

The bank discount rate is the required rate of return of a safe investment guaranteed by the bank.

BREAKING DOWN 'Bank Discount Rate'

Some securities are issued at a discount to par, meaning that investors can purchase these securities at a price lower than the stated par value. For example, Treasury bills, which are backed by the full faith and credit of the U.S. government, are pure discount securities. These short-term non-interest bearing money market instruments do not pay coupons, but investors can purchase them at a discount and receive the full face value of the T-bill at maturity. For example, a Treasury bill is issued for $95. At maturity, the debtholders will receive the face value of $100. The difference between the discount purchase price and the par value is the dollar rate of return. This is the rate at which the central bank discounts Treasury bills, and it is referred to as the bank discount rate.

The bank discount rate method is the primary method used for calculating the interest earned on non-coupon discount investments. It is important to note that the bank discount rate factors in simple interest, not compound interest. In addition, the bank discount rate is discounted relative to the par value, and not relative to the purchase price. For example, assume a commercial paper matures in 270 days with a face value of $1,000 and a purchase price of $970.

First, divide the difference between the purchase value and the par value by the par value.

($1,000 - $970)/$1,000 = 0.03, or 3%

Next, divide 360 days by the number of days left to maturity. To simplify calculations when determining the bank discount rate, a 360-day year is often used.

360/270 = 1.33

Finally, multiply both figures calculated above together.

3% x 1.33 = 3.99%

The bank discount rate is, therefore, 3.99%.

Following our example above, the formula for calculating the bank discount rate is:

Bank Discount Rate = (Dollar Discount/Face Value) x (360/Time to Maturity)

Since the formula uses 360 days instead of 365 days or 366 days in a year, the bank discount rate calculated will be lower than the actual yield you receive on your short-term money market investment. The rate should, therefore, not be used as an exact measurement of the yield that will be received.

  1. Discount

    In finance, discount refers to a situation when a bond is trading ...
  2. Discount Note

    A discount note is a short-term debt obligation issued at a discount ...
  3. Market Discount

    The difference between a bond's stated redemption price and its ...
  4. Discounted Future Earnings

    Discounted future earnings is a method of valuation used to estimate ...
  5. Pure Discount Instrument

    A pure discount instrument is a type of security that pays no ...
  6. 1%/10 net 30

    A way of providing cash discounts on purchases. It means that ...
Related Articles
  1. Investing

    An introduction to commercial paper

    Commercial paper is a short-term instrument that can be a viable alternative for retail fixed-income investors looking for a better rate of return.
  2. Small Business

    Capital Budgeting: Which is Better, IRR or NPV?

    Using internal rate of return and net present value for capital budgeting evaluations often end in the same result. But there are times when using NPV to discount cash flows makes more sense.
  3. Small Business

    Companies That Offer Unique Employee Discounts

    These companies offer employees great discounts and unique incentives you don't find with your average employer.
  4. Retirement

    Senior Discounts Alert: National Parks Pass Rises Aug. 28

    First, Social Security rose a measly 0.3%. Now, the national parks lifetime pass is going up 8 times. Yet another reason to save with senior discounts.
  5. Personal Finance

    9 Student Discounts You Shouldn't Miss

    College students can always stand to save some cash. Here are nine discount opportunities students should explore and exploit.
  6. Investing

    Debt Buybacks Continue

    Many companies are buying bonds back at a discount, and adjusting capital structures to more acceptable levels.
  7. Insights

    The Role of Commercial Banks in the Economy

    We interact with commercial banks daily to carry out simple financial tasks. That said, the function and creation of a commercial bank is anything but simple.
  8. Investing

    Using the Dividend Discount Model

    The dividend discount model is a way of applying net present value analysis to estimate the future dividends a stock will pay. Those dividends are then discounted back to their present value. ...
  9. Investing

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  1. How do central banks impact interest rates in the economy?

    Learn how central banks such as the Federal Reserve influence monetary policy in the economy by increasing or decreasing ... Read Answer >>
  2. What's the difference between the prime rate and the discount rate?

    Learn more about the prime rate and the discount rate and how the Federal Reserve uses these rates in the U.S. economy. Explore ... Read Answer >>
  3. What are the disadvantages of using net present value as an investment criterion?

    While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no ... Read Answer >>
  4. What are the arguments in favor of setting a low discount rate?

    Read about some of the macroeconomic explanations that are used to justify setting a low interest rate at the Federal Reserve's ... Read Answer >>
  5. When and why should the terminal value be discounted?

    Find out why investors use the terminal value, why the terminal value is discounted to the present day, and how it's related ... Read Answer >>
Hot Definitions
  1. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  2. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  3. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  4. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
  5. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
  6. Monero

    Monero is a digital currency that offers a high level of anonymity for users and their online transactions.
Trading Center