Final answer:
Calculating the Loss on sale of a note involves determining its present value using the bank's discount rate and subtracting it from the note's face value. If the discount rate changes, this value must be recalculated to determine a new potential loss given current market conditions.
Step-by-step explanation:
To calculate the Loss on sale of a note that was discounted at a bank, we first must compute the present value of the note using the bank's discount rate. In this scenario, a $20,000 note is discounted at an 8% rate.
For example, a two-year bond issued at $3,000 with an 8% interest rate pays $240 annually. To find the present value (PV) at the same 8% discount rate, we use the present value formula: PV = Payment / (1 + r)^n, where r is the discount rate and n is the number of years.
If interest rates rise, the same bond will need to be recalculated with the new discount rate, say 11%. The present value decreases as the discount rate increases, which is a reflection of the current market conditions where higher returns can be found elsewhere.
Applying this knowledge to the $20,000 note, we can use the formula to find out what the present value is, which subtracted from the face value will give us the loss.
An unattractive investment in a rising interest rate environment may result in a note being sold at a price lower than its face value, which translates to a loss on the sale of the note.