Eli Grace L.

Bajado
BSA – 212

Promissory Note
A promissory note is a financial instrument that contains a written promise by one party (the
note's issuer or maker) to pay another party (the note's payee) a definite sum of money, either
on demand or at a specified future date. A promissory note typically contains all the terms
pertaining to the indebtedness, such as the principal amount, interest rate, maturity date, date
and place of issuance, and issuer's signature.

Types of Promissory Notes

Corporate Credit Promissory Notes
Promissory notes are commonly used in business as a means of short-term financing. For
example, when a company has sold many products but not yet collected payments for them, it
may become low on cash and unable to pay creditors. In this case, it may ask them to accept a
promissory note that can be exchanged for cash at a future time after it collects its accounts
receivables. Alternatively, it may ask the bank for the cash in exchange for a promissory note to
be paid back in the future.

Promissory notes also offer a credit source for companies that have exhausted other options,
like corporate loans or bond issues. A note issued by a company in this situation is at a higher
risk of default than, say, a corporate bond. This also means the interest rate on a corporate
promissory note is likely to provide a greater return than a bond from the same company—
high-risk means higher potential returns..

Investment Promissory Notes

Investing in promissory notes, even in the case of a take-back mortgage, involves risk. To help
minimize these risks, an investor needs to register the note or have it notarized so that the
obligation is both publicly recorded and legal. Also, in the case of the take-back mortgage, the
purchaser of the note may even go so far as to take out an insurance policy on the issuer's life.
This is perfectly acceptable because if the issuer dies, the holder of the note will assume
ownership of the house and related expenses that he or she may not be prepared to handle.

These notes are only offered to corporate or sophisticated investors who can handle the risks
and have the money needed to buy the note (notes can be issued for as large a sum as the
buyer is willing to carry). After an investor has agreed to the conditions of a promissory note, he
or she can sell it (or even the individual payments from it), to yet another investor, much like a
security.

Discounted Promissory Notes

Banks and other lenders may lend money to businesses and people for short periods of time
such as 30, 60, or 90 days. These loans are called short-term loans. When a bank makes a short-
term loan, it may require the borrower to sign a note and pay the interest when the loan is
made. When interest is collected in advance, it is known as bank discount. Because the interest
is paid in advance, the note itself does not show any interest rate, and it is called a non-
interest-bearing note. The bank collects the bank discount by deducting it from the principal, or
face, of note. The amount the borrower gets is the principal of the note less the discount. When
the loan is due, only the principal of the note is paid. Obtaining a loan in this way is known as
discounting a note.

Problem in Discounting of Promissory Notes

Obtain the amount paid for the promissory note. For instance, if you gave the issuer $9,800,
this is the amount you paid for the promissory note.
Determine the redemption value of the note. For instance, if you are to receive $10,000 at the
end of the note term, this is the redemption value of the promissory note.
Find the difference between the redemption value and the amount you paid for the note. For
example, the difference between $10,000 and $9,800 is $200.
Calculate the discount. In dollar terms the discount is $200; however, the discount is usually
expressed in percentage terms. Divide the difference between the redemption value and the
amount paid by the amount paid to find the discount in percentage terms. The calculation is
$200 divided by $9,800. The answer is .0204. Multiply this by 100 for the percentage. The
answer is 2.04 percent.