Now the seller of the goods (Firm B) has a promise of payment in three months’ time, but it does not have the money. It can, however, take the bill to a bank or a discount house, which will buy or discount the bill. To discount a bill means to buy it for less than its face value. For example, in this particular case, the bank or discount house might buy the bill for 97 000 $. When the bill comes due for payment, the bank or discount house will receive 100 000$. In effect, it has charged an interest payment of 3000$ for making a loan of 97000$ for three months.
This system enables the buyer of the goods to have three months’ credit, while the seller does not have to wait three months for payment.
If Firm A is not well known in the banking world, a discount house or bank may not be willing to discount the bill. In this case, the bill can be taken to an accepting house (usually a well-known merchant bank) which, for a fee, will also write the word ‘accepted’ on the bill and sign it. In doing so it has guaranteed payment should Firm A default in its payment. There will now be no problem in getting the bill discounted.
3.6.4 Treasury bills
These are a type of bill of exchange issues by the British government. They have a life of 91 days (three months) and are the means by which the government borrows for a three-month period. They are issued in denominations ranging from 5000$ to 1 000 000$, and are sold to the highest bidders in weekly auctions. Discount houses and other financial institutions buy (i.e. discount) these bills.
When Treasury bills fall due for repayment, the government makes a payment equal to their full face value. When it sold them, however, it took the highest price it could obtain. For example, in the weekly auction, the highest bid for the 250 000$ Treasury bill in Figure 14.8 might be 244 000$. In three months’ time, the Bank of England will pay the holder of this bill 250 000$. The difference of 6000$ is the amount of interest the government will have had to pay in order to borrow 244 000$ for three months.
3.7 Different types of bank
3.7.1 The Bank of England
This is the central bank of the UK. It is a state-owned bank; other banks are privately owned. It has many important functions:
1. It is the government’s bank. It receives the government’s income from taxation and other sources, and makes payments on its behalf.
2. It is the bankers’ bank. Other banks keep account at the Bank of England and use them to settle debts between themselves. Thus, if Barclays makes a payment to Lloyds, it will do so by drawing a cheque on its account at the Bank of England. The central banks of other countries, and international organizations such as the International Monetary Fund, also keep account at the Bank of England.
3. It is responsible for managing the National Debt. The Bank of England carries out the borrowing of the central government, makes interest payments to those who hold the government’s debt, and repays loans when they fall due.
4. The Bank of England is the sole note-issuing authority for England and Wales. It produced as many as eight million new notes per day. It checks and destroys worn notes.
5. It is the lender of last resort. This means that it will come to the aid of other banks if there is a shortage of cash in the banking system.
6. It is responsible for making sure that the banking system does not operate in ways which conflict with government policy. The Bank of England is able to influence the amount of bank lending and the rate of interest being charged on bank loans.
7. It holds the official stocks of foreign currency (e.g. dollars, francs, marks, yen, etc.) and the gold reserves. It operates in the foreign exchange market when it wishes to influence the exchange rate, that is, the price of pound in terms of other currencies.
3.7.2 The discount houses
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