Discount Instrument

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Discount Instrument</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="0%" align="left" valign="top"><p class="word_list"> <a href="#accrual instruments">accrual instrument</a><p class="word_list"> <a href="#discount instruments">discount instrument</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table5"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">In the fixed income markets, there are a variety of instruments that, rather than paying interest as <a href="../articles/coupon_bond.htm">coupons</a>, pay it at maturity. They are issued at some price and later mature for a greater value. This article focuses on short-term, money market forms of these instruments. See the article <i> <a href="../articles/zero_coupon_bond.htm">zero-coupon bonds</a></i> for the longer-term forms.</p> <p class="body">The instruments fall into two categories.</p> <p class="body"><img border="0" src="../images/bullet.gif" width="20" height="10">The first category might be called <b><a name="accrual instruments">accrual instruments</a></b>. These instruments are issued at some <a href="../articles/par_value.htm">face value</a> and mature for a value equal to that face value plus interest.</p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">The second category is <b><a name="discount instruments">discount instruments</a></b>. These have a face value that represents their maturity value. They are issued at a discount from that face value.</p> <p class="body">This distinction is illustrated in Exhibit 1.</p> <div align="center"> <center> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="370" cellpadding="0" id="table6"> <tr> <td> <p class="exhibit_header"><span class="exhibit_header">Cash Flows of Accrual and Discount Instruments</span><br> <span class="exhibit_subheader">Exhibit 1</span></td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td> <img border="0" src="../images/ex_1_discount_instrument_a.gif" width="360" height="219"><br> <img border="0" src="../images/ex_1_discount_instrument_b.gif" width="360" height="219"></td> </tr> <tr> <td> <p class="exhibit_legend">Cash flows of an accrual instrument are compared with those of a discount instrument. The accrual instrument is issued for its face value and matures for its face value plus interest. The discount instrument is issued at a discount from its face value and matures for its face value. In both graphs, the face value is assumed to be <a href="../articles/currency_codes.htm">USD</a> 100.</td> </tr> </table> </center> </div> <p class="body">Accrual instruments are quoted as <a href="../articles/yield.htm">yields</a>. Discount instruments can be quoted on a price or yield basis. Yields are calculated differently for the two types of instruments, so a yield quoted for one is not comparable to a yield quoted for the other. </p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table7"> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">Yields for accrual instruments are quoted as <a href="../articles/compounding.htm">simple interest rates</a>. Yields for discount instruments are quoted as <a href="../articles/discount_yield.htm">discount yields</a>. If comparisons with other instruments' yields need to be made, a discount instrument's yield may be converted to <a href="../articles/bond_equivalent_yield.htm">bond-equivalent yields</a>.</p> <p class="body">In the money market, examples of accrual instruments include</p> <p class="bullet"><img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/certificate_of_deposit.htm">certificates of deposit</a></p> <p class="bullet"><img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/fed_funds.htm">fed funds</a>, and </p> <p class="bullet"><img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/repo.htm">repos</a></p> <p class="body">Discount instruments include</p> <p class="bullet"><img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/treasury_bill.htm">T-bills</a>,</p> <p class="bullet"><img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/commercial_paper.htm">commercial paper</a>, and</p> <p class="bullet" style="margin-bottom: 32"> <img border="0" src="../images/bullet.gif" width="20" height="10"><a href="../articles/bankers_acceptance.htm">bankers acceptances</a>.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table9"> <tr> <td width="100%"> <p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/bankers_acceptance.htm">bankers acceptance</a> An acceptance that has a bank as its drawee.</p> <p class="explanatory_text"> <cop yrigh t( c)c ont i ngen cy anal y sis, 2 00 5> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/bond_equivalent_yield.htm">bond-equivalent yield</a> A convention for converting discount yields to a form more comparable to bond yields.<p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/commercial_paper.htm">commercial paper</a> Short-term promissory notes issued primarily by corporations.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/compounding.htm">compound interest</a> Any of several methods of crediting interest in which interest is earned on interest.</strong><p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/discount_yield.htm">discount yield</a> A formula for calculating yield on a discount instrument.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/fed_funds.htm">Fed funds</a> Deposits held by US banks in accounts at their regional Federal Reserve banks.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/fixed_income_term_structure.htm">fixed income term structure</a> Refers collectively to a spot curve, forward curve, discount curve, yield curve or any other curve that describes the time value of money.<p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/libor.htm">Libor</a> London Interbank Offered Rate.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/par_value.htm">par value</a> A stated value for a security.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/repo.htm">repurchase agreement</a> An agreement to sell and subsequently repurchase a security.</strong><p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/treasury_bill.htm">Treasury bill</a> US Treasury security with with a maturity of a year or less at the time of issue.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/yield.htm">yield</a> Any of several metrics of the income or return to be earned from an investment.</strong></td> </tr> </table> </td> </tr> <tr> <td height="30" 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Choudhry (<a target="_blank" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm">2002</a>) covers accrual and discount instruments in detail.</p> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table11"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap370"> <area target="_blank" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm" shape="rect" coords="0, 0, 82, 124"> </map> <img border="0" src="../images/book_fabozzi_mann_choudhry_(2002)_125.gif" usemap="#FPMap370" width="83" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table12"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm"> The Global Money Markets</a></td> </tr> <tr> <td colspan="3"> <p 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