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.

RELATED TERMS
  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. Discounting

    Discounting is the process of determining the present value of ...
  4. 1%/10 net 30

    1%/10 net 30 is a way of providing cash discounts on purchases, ...
  5. At A Discount

    If shares are sold for less than their par value, they are sold ...
  6. Discount Bond

    A discount bond is a bond that is issued for less than its par ...
Related Articles
  1. Investing

    4 Types Of Money Market Yields

    Learn to calculate, and discover the difference between the 4 types of yields; bank discount yield, holding period yield, effective annual yield, and money market yield
  2. 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.
  3. 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.
  4. Investing

    Discount Broker

    A discount broker is a stockbroker who carries out "buy" and "sell" orders at a reduced commission compared to a full-service broker, but provides no investment advice.
  5. Investing

    The Basics Of The T-Bill

    The U.S. government has two primary methods of raising capital. One is by taxing individuals, businesses, trusts and estates; and the other is by issuing fixed-income securities that are backed ...
  6. Investing

    Valuation Of A Preferred Stock

    Determining the value of a preferred stock is important for your portfolio. Learn how it's done.
  7. Retirement

    But We’re Too Young for a Senior Discount...

    You don’t have to be 65 to get discounts on food, travel, entertainment and more. A look at some deals you can find with a little digging.
  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. Managing Wealth

    6 Discounts You Can Get For Paying Cash

    If you have the money in your pocket, it may get you a great deal on your purchase.
RELATED FAQS
  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 is the difference between the cost of capital and the discount rate?

    Learn about the differences between the cost of capital and the discount rate as they relate to estimating a required return ... Read Answer >>
  3. How can I calculate the carrying value of a bond?

    Learn what the carrying value of a bond means, how it can change, and the easiest way to calculate a bond's carrying value ... Read Answer >>
  4. How does a high discount rate affect the economy?

    Find out what would happen if the Federal Reserve decided to set a very high discount rate, the rate at which banks can borrow ... Read Answer >>
Hot Definitions
  1. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  2. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  3. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  4. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  5. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  6. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
Trading Center