PRERNA KANDHARI ROLL NO.

21

DISCOUNT MARKET

Submitted by:ROLL NO. 21-30

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Introduction and discounting service Concept of Discounting

Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date. The discount, or charge, is simply the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt. Multiplying an amount by a discount rate to compute its present value(the 'discounted value'). It is the opposite of 'compounding' where compound interest rates are used in determining how an investment will grow on a monthly or yearly basis. For example, $1,000 compounded at an annual interest rate of 10 percent will be $1,610.51 in five years. Conversely, the present value of $1,610.51 realized after five years of investment is $1,000 when discounted at an annual rate of 10 percent. The discount is usually associated with a discount rate, which is also called the discount yield. The discount yield is simply the proportional share of the initial amount owed (initial liability) that must be paid to delay payment for 1 year. Discount Yield = "Charge" to Delay Payment for 1 year / Debt Liability It is also the rate at which the amount owed must rise to delay payment for 1 year.

Parties Involved in Discounting

The three parties directly involved are: the one who sells the receivable, the debtor (the account debtor, or customer of the seller). The receivable is essentially a financial asset associated with the debtor's liability to pay money owed to the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices (the receivables) at a discount to the third party, the specialized financial organization ,often, to obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights associated with the receivables. Accordingly, the factor obtains the right to receive the payments made by the debtor for the invoice amount and, , must bear the loss if the account debtor does not pay the invoice amount due solely to his or its financial inability to pay. Usually, the account debtor is notified of the sale of the receivable, and the factor bills the debtor and makes all collections; however, where the client (seller) collects the accounts sold to the factor, as agent , also occurs. There are three principal parts to "advance" factoring transaction; (a) the advance, a percentage of the invoice face value that is paid to the seller at the time of sale, (b) the reserve, the remainder of the purchase price held until the payment by the account debtor is made and (c) the discount fee, the cost associated with the transaction which is deducted from the reserve, along

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with other expenses, upon collection, before the reserve is disbursed to the factor's client. Sometimes the factor charges the seller (the factor's "client") both a discount fee, for the factor's assumption of credit risk and other services provided, as well as interest on the factor's advance, based on how long the advance, often treated as a loan (repaid by set-off against the factor's purchase obligation, when the account is collected), is outstanding.

Advantages of discounting
1. The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank. Different types of loans are available from Federal Reserve Banks and each corresponding type of credit has its own discount rate. 2. The interest rate used in discounted cash flow analysis to determine the present value of future cash flows. The discount rate takes into account the time value of money (the idea that money available now is worth more than the same amount of money available in the future because it could be earning interest) and the risk or uncertainty of the anticipated future cash flows (which might be less than expected). 3. It gives you access to an ongoing supply of cash that grows as your sales grow. 4. By making use of a factoring facility you can benefit from improved profitability as you can pay suppliers earlier, buy in larger quantities and take advantage of any volume discounts available. 5. Knowing exactly when you are going to be paid assists with financial planning. 6. You may find that some customers respect factors and pay their debts more promptly. 7. You receive cash as soon as orders are invoiced which gives you the option of using it for capital investment and to fund future orders. 8. The facility provides flexibility for the business and access to a range of additional products such as cash flow loans, trade or transactional finance.

Type of Financing Financing addresses the ways in which individuals, businesses and organizations raise, allocate and use monetary resources over time, taking into account the risks entailed in their projects. It is a type of credit transfer financing. (Economics, Accounting & Finance / Banking & Finance) a method of settling a debt by transferring money through a bank or post office, esp for those who do not have cheque accounts.

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Banks and other lenders often transfer credit risk in order to liberate capital for further loan intermediation. Beyond selling loans outright, lenders are increasingly active in the market for syndicated loans. Loans that are sold or syndicated tend to have better covalent packages. A payment order or possibly a sequence of payment orders made for the purpose of placing funds at the disposal of the beneficiary is credit transfer. Both the payment instructions and the funds described therein move from the bank of the payor/originator to the bank of the beneficiary, possibly via several other banks as intermediaries and/or more than one credit transfer system.