What is Rediscount
Rediscount is the act of discounting a short-term negotiable debt instrument for a second time. Banks may rediscount these short-term debt securities to assist the movement of a market that has a high demand for loans. When there is low liquidity in the market, banks can generate cash by rediscounting short-term securities.
BREAKING DOWN Rediscount
To entice investors, debt issuers may offer their bonds at a discount to par, meaning that investors can purchase a bond for less than its par value and receive the full par value of the bond when it matures. If the first debt offer does not generate much interest, the issuer may apply an additional discount to the bond, increasing the difference between the discount price and the par value. When this occurs, the issuer is said to rediscount the bonds.
The term “rediscount” also refers to the process by which a central bank or the Federal Reserve bank discounts a short-term debt security that has already been discounted by a bank or discount house. A central bank's discount facility is often called a discount window. The term comes from the days when a clerk would go to a window at the central bank to rediscount a company's securities. Federal Reserve Banks are empowered to accept loans and other bank obligations as collateral for advances at the discount window. The discount window is used by the Fed to rediscount private securities as a means to directly provide funding to banks at a particular interest rate and, thus, influence banks' marginal cost of funds. For example, a customer that borrows $10,000 from the bank will sign a promissory note stating that it will repay the bank $11,500 after a year. This note is discounted by the bank which loans less than the $11,500 face value of the note. If the bank wanted to obtain additional reserves from the Federal Reserve, it could rediscount this eligible note at the Fed’s discount window for, say $10,800.
In so doing, the Federal Reserve would take ownership of the loan note and provide the member bank with funds against the amount the note promises to pay at maturity.