A discount is a deduction allowed on a financial obligation. When the value of an obligation is known at some future date, the process of finding its value at some earlier date is called discounting. The rate of discount is the per cent of the maturity value charged as bank discount for a discount period of unit length of time. One year is generally taken as the unit length of time. A special case of discounting an obligation is that of finding its present value when its maturity value is known. The present value of a discounted note is commonly referred to as the net proceeds of the note.

A very general practice followed by banks in making loans is to require a borrower to make a note bearing no interest until after maturity, and to discount this note immediately, giving the borrower the net proceeds; the interest charged by the bank for this loan is then the bank discount on this note. Since this note bears no interest until after maturity. the borrower is said to pay the interest in advance. For example, suppose a man requests a loan from a bank, promising to pay Rs. 100 in a year in settlement of this obligation. If the bank charges 5% annual discount, the banker computes the present value of Rs. 100 (due in a year ) to be Rs. 95, i.e., he deducts 5% of 100 from Rs. 100 and pays only Rs. 95 to the borrower. Thus the bank discount is Rs. 5 and the net proceeds are Rs. 95, although the borrower is said to have obtained a Rs. 100 loan.

Thus the above transaction may be described as follows: The borrower receives Rs. 100 but immediately returns Rs. 5 to the bank as 5% interest (paid in advance) on Rs. 100.

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