Introduction to Finance

secured loan 
loan backed by 
collateral
unsecured loan 
loan that is a 
general claim against the borrower’s 
assets
prime rate 
interest rate on short-
term unsecured loans to highest-
quality business customers
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We say that, “in theory,” the prime rate is the lowest borrowing rate for unsecured loans because almost everything 
is negotiable. In fact, there have been many instances in which large corporate borrowers have negotiated bank loans 
at interest rates below the prevailing prime rate.

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3.7 The Bank Balance Sheet
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paid along with the principal amount of the loan when the loan contract matures. In some 
instances, a discount loan or note is off ered. With a discount loan, the interest is deducted from 
the stated amount of the note at the time the money is lent. The borrower receives less than the 
face value of the note, but repays the full amount of the note when it matures.
A given discount rate results in a higher cost of borrowing than an interest loan made for 
the same rate. This is true, because under the discount arrangement actual money received by 
the borrower is less, although the amount paid for its use is the same. For example, if $10,000 
is borrowed on a loan basis at an interest rate of 5 percent for one year, at maturity $10,000 
plus $500 interest must be repaid. In general terms, the annual percent cost of borrowing for a 
one-year loan with interest paid annually is determined as follows:
Standard Loan:
Percent annual rate =
Interest paid
Amount borrowed
× 100 (3.1)
For our example, we have,
Percent annual rate =
$500
$10,000
× 100 = .05 × 100 = 5.0 %
In contrast, if the $10,000 is borrowed on a discount basis and the rate is 5 percent, a 
deduction of $500 from the face value of the note is made and the borrower receives only 
$9,500. At the end of the year, the borrower repays the face amount of the note, $10,000. In 
general terms, the percent annual rate on a one-year discount loan is calculated as follows:
Discount Loan:
Percent annual rate =
Discount amount
Amount borrowed − Discount amount
× 100 (3.2)
For our example, we have,
Percent annual rate =
$500
$10,000 − $500
× 100 =
$500
$9,500
× 100 = .0526 × 100 = 5.26%
In the fi rst case, the borrower has paid $500 for the use of $10,000; in the second case, 
$500 has been paid for the use of only $9,500. The eff ective rate of interest, therefore, on the 
discount basis is approximately 5.26 percent compared with the even 5 percent paid when the 
$10,000 was borrowed on a standard loan basis.
Loans to individuals also are an important category for commercial bank lending. Loans 
to individuals constitute about one-fi fth of all bank loans. Credit cards and related loan plans 
comprise a little less than half of all bank loans to individuals.