Discount Note

A Discount Note is a short term debt obligation that an investor can purchase from government-insured agencies such as Freddie Mac, Federal Home Loan Banks and other corporations that have very high credit ratings. Unlike other types of bonds, Discount Notes are issued at below face value and do not pay interest. Discount Notes typically have a short lifespan with the maximum maturity length of one year. Once the Discount Note reaches maturity, the investor will receive the face value of the note, thus making a profit. The profitability of any Discount Note is determined by the difference between its purchase price (at the discounted rate) and the face value of the note at maturity.

Consider the following example: Freddie Mac issues 100,000 Discount Notes at below face value for $95 to raise money for a housing construction project. Each Discount Note has a face value of $100 and a maturity length of one year. The investor spends $9,500 to buy 100 Discount Notes. After one year, the Discount Notes reach maturity and the investor receives $10,000 from Freddie Mac. The investor made a profit of $5,000 over the course of one year.

Discount Notes are considered to be some of the safest investments today because they are issued by government-insured organizations that are guaranteed to repay their debt obligations.