loan is more apt to be thought of as the maturity value.
And so:Definition 2.1.2
The face value of a discount note is its maturity value.Thus, the meaning of the term face value depends on
whether we are talking about interest or discount.
One common example of a discount note is U.S.
Savings Bonds (since 2001 sometimes referred to as
“Patriot Bonds”). Savings bonds can be purchased at
most banks, and many employers offer a program that
allows their workers to buy them by payroll deduction.
A savings bond is actually a promissory note issued by
the U.S. government, so when you buy a savings bond
you are loaning money to Uncle Sam. Savings bonds
used to be a much more popular investment than they
are today, but many people still do use them as a way to
save, and they are often given as gifts for occasions like
the birth or adoption of a child.
There are several types of savings bonds, but the type most familiar to most people
(Series EE bonds) is sold for half of its face value. This is one reason why savings bonds
are often used as contest prizes or promotional giveaways since a “$50 U.S. savings bond”
actually only costs $25, allowing the prize to be advertised as being twice its actual cost
and current value.^1 The $50 face value reflects the amount the government guarantees that
it will pay for the bond on maturity, which is usually many years away. (As of early 2005,
the maturity date for a savings bond was 20 years from the date purchased, though the
time to maturity changes depending on prevailing interest rates when the note is issued.)
Since the $50 face value encourages us to think of $50 as the size of the note, it is natural
to consider a savings bond as a type of discount note.^2
Treasury bills (also known as T bills for short) are another common example of
a discount note. While they may be less familiar than savings bonds, they are actually
less complicated and in many ways better example of a discount loan. Treasury bills are
short-term loans to the U.S. federal government, carrying terms ranging from a few days
to 6 months, though the most common terms are 4, 13, or 26 weeks. They are sold at a
discount to their maturity values. For example, you might buy a $1,000 face value T bill
for $985, a $15 discount from the maturity value.
T bills cannot normally be purchased through banks or payroll deductions the way
that savings bonds can, and while savings bonds are issued with face values as low as
$50, T bills are sold in $1,000 increments, with $1,000 being the minimum face value.
T bills can be purchased through investment brokers, or directly from the government
through its Treasury Direct program (www.treasurydirect.gov).
Also, unlike savings bonds, the price of a T bill is not set in advance. When a T bill is
issued, the government offers it for sale on the market. The prices are set at auction, meaning
that the bonds are sold to whoever is willing to pay the highest prices for them. Like anything
else sold on the open market, the selling price of a $1,000 T bill is the best offer that the seller
(in this case, the federal government) can get for the thing being sold. Whatever the price
turns out to be, though, the note will clearly sell at a discount to its maturity value.(^1) Let’s be honest: that’s also a reason why they make great gifts.
(^2) Savings bonds are actually quite complicated animals, with all sorts of features that ordinary discount notes lack.
They can, for example, be cashed in before the maturity date or left to grow beyond the maturity date. The rates
paid on savings bonds may vary, depending on the specifi c type of savings bond, date of purchase, and prevailing
interest rates. Since the rates vary, they actually usually reach their maturity value long before their supposed
maturity date, which is based on a guaranteed minimum interest rate. Furthermore, though they resemble discount
notes in many ways, their values actually are not calculated by simple discount. Nonetheless, their basic premise
makes an accessible and familiar illustration of a discount note. Because of all the extra bells and whistles,
though, savings bonds will not be further discussed in this chapter.
58 Chapter 2 Simple Discount
U.S. Savings Bonds are sold at a discount to their face value.
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