The Operation Of Discount

Every person in this chain of credit is confronted with the problem of

paying his debts as they mature by the use of the amounts due him from

other people. Since it is rarely possible to arrange maturities on

both sides in such a way that the amounts due to be paid him at a

given date shall at least equal those he is due to pay on that date,

some means of transforming claims against other people due in the

future into resent means of payment must be found. The one

universally employed is the discount of commercial paper. By this is

meant the exchange at a bank of his own promissory notes due at times

when debts of equal or greater amount due him mature, or of bills of

exchange drawn against his debtors, for cash or credits on a checking

account. These latter are available as means of payment at any time.



As a consideration for this accommodation, the bank charges interest

for the period intervening before the maturity of the paper

discounted. Sometimes this charge is paid at the time the paper is

purchased and sometimes at the date of its maturity. The term

"discount" technically means taking interest in advance by making

available as means of present payment in any of the above mentioned

forms a sum less than the amount the bank expects to collect at the

date of the maturity of the discounted paper. If the interest is paid

when the discounted paper matures, the process is technically called

a loan. However, since the time of collecting interest makes no

essential difference in the nature of the transaction, the process is

commonly described as the discount of commercial paper, regardless of

whether the interest is collected in advance or not.