Question

1. Fruit of the Loom has a banker's acceptance drawn in Banquet Paribas with a face value of $10 million due in 90 days. Paribas with withhold an acceptance fee of $10,000 at maturity. Fruit of the Loom's bank is willing to buy the acceptance at a discount rate of 6 percent compounded quarterly.

A. How much will fruit of the loom receive if it sells the acceptance?

B. What is the all-in cost of the acceptance, including the acceptance fee?

Answer 1

Since there is theoretically no interest payable on a bankers' acceptance, the investor would want to pay less than the nominal amount for the acceptance in order to receive a certain yield on his investment when, at redemption, he receives the nominal amount from the borrower. The rate quoted on a bank acceptance is the rate of discount on the nominal amount of the acceptance that is used to calculate the amount advanced by the lender. The rate is given as an annual rate.

A. In the following question a BA (bank acceptance) is issued at 6%. The nominal amount of the BA is 10 million and it is issued for 90 days.

The discount on this BA would be worked out as follows:

Discount = N x d/365 x di/100

where

N	=	nominal value
d	=	tenor in days
di	=	discount rate as a fixed amount

In this case

Discount = ($10 million- $10,000) x 90/365 x 6/100
                 = $ 147,797

The proceeds which the borrower (drawer) would get at issue date, which is equal to the amount that the investor or lender would pay would be:

Proceeds = nominal amount - discount

In this case fruit and looms recives = ($10,000,000-$10000) - $147,797
                   = $9,852,203

B.

all-in cost of this banker’s acceptance to the exporter is (10,000,000 – 9,852,203)/9,852,203 = 0.0150 per 90 days i.e 1.5% for 90 days