discounting of bill

Definition
Cashing or trading a bill of exchange at less than its par value and before its
maturity date. The cash thus realized varies according to the number of days unt
il maturity and the risk involved.

Bills of Exchange
?The bill of exchange (B/E) is used for financing a transaction in goods which m
eans it is essentially a trade related instrument. ?According to Negotiable Inst
ruments Act, 1881: The bills of exchange is an instrument is writing, containing
an unconditional order, signed by the maker, directing a certain person to pay a
certain sum of money, only to, or to the order of, a certain person, or to the
bearer of that instrument .

Types of Bills
1.Demand Bill Payable immediately on presentment to employee.
2.Usance Bill Time period recognized for payment of bills.
3.Documentary Bill These B/E are accompanied by documents that confirm trade has
taken place.
4.Clean Bills These Bills are not accompanied by any documents.
Interest rate charged is higher than documentary bill

Creation of B/E ?Two parties i.e. seller sells goods or merchandise to a buyer.
?Seller would like to be paid immediately but buyer would like to pay after some
time.
?Seller draws a B/E of a given maturity on the buyer.
?Seller (Creditor) becomes drawer of the bill and buyer (Debtor) becomes drawee
of the bill.
?Seller sends the bill to buyer for his acceptance.
?Acceptor may be buyer himself or third party

Discounting of B/E
Holder of an accepted B/E has two options 2.Hold on to B/E till maturity and the
n take the payment from the buyer. 3.Discount the B/E with discounting agency. T
he act of handing over an endorsed B/E for ready money is called discounting the
B/E. The margin between the ready money paid and face value of the bill is call
ed the discount. The maturity of a B/E is defined as the date on which payment f
alls due. ?Normal maturity periods are 30, 60, 90 or 120 days. ?Bills maturing w
ithin 90 days are most popular. ?Discounting agencies are banks, NBFC, company,
high net worth individuals etc

Advantages to investors
?Short-term source of finance. ?Since it is not lending, no tax at source is ded
ucted while making the payment charges which are very convenient. ?Rates of disc
ount are better than those available on ICDs. ?Flexibility, not only in the quan
tum of investments but also the duration of investments
Advantages to Banks
? Safety Funds B/E is a negotiable instrument bearing the signature of two parti
es considered good for the amount of bill, so he can enforce his claim easily. ?
Certainty of Payment A B/E is a self liquidating asset with the banker knowing
in advance the date of its maturity. ? Profitability The discount on bill is fro
nt ended, the yield is much higher than in the other loans and advances, where i
nterest paid quarterly or half yearly.
Contd .
?Evens out inter-bank liquidity problem The development of healthy parallel bill
discounting market would have stabilized the violent fluctuations in the call m
oney market as banks could buy and sell bills to even out their liquidity mismat
ches