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Discuss the Meaning of Discounting Bills of Exchange

Last Updated : 02 Aug, 2023
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When a bank or other financial institution buys a bill of exchange from the holder before its maturity date at a reduced price, this financial activity is referred to as discounting bills of exchange.

A common financial transaction known as “discounting” enables the holder of a bill of exchange to receive immediate cash by selling the bill to a financial organization for a lower price.

Bills of Exchange

Bills of Exchange

Discounting Bills of Exchange

  • A bill of exchange is created by the seller as a means of payment when they offer goods or services to a buyer.
  • The seller can then submit the bill of exchange for discounting to a financial institution (like a bank).
  • The financial organization determines the bill’s present worth by discounting the future value, or the amount the buyer owes, according to the current interest rates and the remaining time until maturity.
  • After taking ownership of the bill and paying the seller the bill’s discounted worth, the financial institution.
  • The financial institution gets the entire amount due from the buyer when the bill matures.

Basis of Discounting of Bills of Exchange

The financial institution usually bases its discount rate on both the current market interest rates and the creditworthiness of the parties involved. The discount rate compensates the financial institution for the risk associated with buying the bill and represents the time value of money.

A bill of exchange is a written request for payment of a specific sum of money at a specific future date from one party (the writer) to another party (the drawee). Before the bill’s maturity date, the holder (the payee) may decide to sell it to a bank or other financial entity in order to receive cash right away, albeit at a reduced price.

The financial organization chooses the discount rate that will be applied to the bill of exchange after considering a number of variables, including the creditworthiness of the parties involved, how long the bill will be outstanding, and current market interest rates. The difference between the face value and the discounted price of the bill represents the interest that was paid to the bank or financial institution, and the payee gets less money than the bill’s face value.

The holder of the bill may be able to access the cash they may need for business operations or other expenditures quickly by having their bill discounted. The risk of non-payment by the drawee is assumed by the bank or financial entity that buys the bill of exchange, and if the bill is not paid at maturity, legal action may be taken to recover the amount owed.

FAQs on Discounting of Bills of Exchange

Q 1. How does the bill of exchange discounting procedure work?

Answer-

Discounting a debt refers to cashing it out before its maturity date. Bank subtracts a sum (called “discounting charges”) from the total of the payment.

Q 2. What does “discounting bills” mean?

Answer-

In this type of lending, the bank accepts the bill that the borrower has drawn on his (the borrower’s) client and pays him right away after deducting a certain amount as a discount or fee.

Q 3. What does it mean to discount bills of currency or dollars?

Answer-

If the bill’s owner requires money, he can go to the bank to have the bill paid before it’s due. The bank must settle the invoice after deducting some interest. (called discount in this case). The act of cashing the money at the bank is referred to as discounting it.


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