A bank discount is a bank charge that is made for payment of a note at some point prior to maturation. It is applied at the time that the  note/loan is extended, and is automatically deducted from the loan amount that is used to calculate the schedule of payments on the loan. This means that the receiver of the loan simply repays the face value of the loan with little/no interest.

To receive a bank discount, an individual or a firm should possess a solid record of previous financing with the institution. If the past loan history shows no late payments and no complications with the loans, then the chances of receiving a bank discount are greatly improved.

The level of bank credit is also a factor. The eligibility for receiving a bank discount is impacted by the current assets and liabilities of the borrower. If there is a high credit rating, then the chances of getting a bank discount are enhanced. These types of customers are considered as good credit  risks with the bank can afford to extend a bank discount with the expectation of doing more business with the customers in the future.

4.1.1 The Formula

In section 2.4.2, we deal with a simple discount at a discount rate. Similarly, we can calculate the bank discount (D) as follows;

D = Sdt

where S is the maturity value, d is the discount rate, and t is time.

The money received for the discounted note is called the proceeds. The proceeds (P) are obtained by deducting the bank discount (D) from the maturity value (S) of the note:

P = S-D

From both formulas, we can calculate the proceeds as follows:

P = S-D = S-Sdt = S(1-dt)