Definition
Rediscount refers to the practice where banks and financial institutions sell short-term negotiable debt instruments like bankers’ acceptances and commercial paper, which they have previously discounted. When a financial instrument is discounted, it is exchanged for immediate cash, less an amount that reflects the interest rate over the period until maturity. Rediscounting allows banks to obtain liquidity by moving these pre-discounted instruments to another financial institution, thereby converting them into cash at a new, adjusted interest rate.
Examples
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Bankers’ Acceptances:
- A bank holds bankers’ acceptances as part of its portfolio. These acceptances were initially discounted when the original holders needed immediate cash. The bank may decide to rediscount these instruments with another bank to ensure liquidity.
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Commercial Paper:
- A financial institution that possesses discounted commercial paper (short-term unsecured debt issued by corporations) might sell these to another financial institution to obtain cash adjusted for the current interest rate at the time of rediscounting.
Frequently Asked Questions
How does rediscounting work?
Rediscounting involves a bank selling previously discounted instruments to another financial institution to obtain immediate liquidity. The selling price is adjusted based on the current interest rate.
Why do banks use rediscounting?
Banks use rediscounting to manage liquidity needs, secure immediate cash, and efficiently handle large volumes of short-term debt instruments.
Can all types of short-term debt instruments be rediscounted?
Typically, negotiable instruments like bankers’ acceptances and commercial paper are commonly rediscounted. The eligibility of debt instruments for rediscounting may be subject to the policies of individual financial institutions.
What is the difference between discounting and rediscounting?
Discounting is the initial process of selling a debt instrument for less than its face value to obtain early cash. Rediscounting is selling that pre-discounted instrument to another institution to again secure liquidity.
Related Terms
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Discount: The process of selling a debt instrument at less than its face value to get immediate cash, factoring in the interest due until the maturity date.
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Bankers’ Acceptances: A short-term debt instrument guaranteed by a commercial bank, typically used in international trade.
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Commercial Paper: Unsecured, short-term debt issued by a corporation, generally for financing accounts receivable and inventories.
Online Resources
Suggested Books for Further Studies
- “Principles of Banking” by American Bankers Association
- “Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives” by Sunil K. Parameswaran
- “Modern Banking” by Shelagh Heffernan
Fundamentals of Rediscounting: Banking Basics Quiz
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