How a Bill Of Exchange operate first we have to read the following points:
- A person who wants to purchase goods but he has no money, may agree to accept the bill of exchange drawn upon him at some future date for the value of the goods he wants to purchase. For example, Mr.B(a retail trader) wishes to purchase furniture from a furniture manufacturer(Mr.A) has no money. Mr.A is agree to sell furniture for a 90 days credit worth Rs.10,000.
- The drawer (Mr.A) draws a bill for Rs.10,000 on the cutomer (Mr.B), the drawee, who accept it (thus becoming the acceptor of the bill) and returns it to the drawer. The drawer delivers the furniture and has 90 days bill for Rs. 10,000.
- He can keep the bill till due date and present it on the due date before the acceptor.
- When a drawee (the acceptor) acknowledges the obligation in the bill he is bound by law to honour the bill on the due date. If he is a reputable person the bill is as good as money, any bank will discount it . There are special kind of banks which do this job and are called “discount houses”. What do the discount house do ? They cash the bill by giving the drawer the present value of the bill.
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present value = face value of the bill₋ interest at an agreed rate for the number of days the bank has to wait
so the drawer who discounts the bill with the bank get less then the face value.
5. On the due the date the bank will present the bill to the acceptor, who honours it by paying the full value. The bank has entered the amount of interest it deducted when it discounted the bill.
Where does the acceptor get the money to honour the bill?
The answer is that he was given 90 days to sell the the goods at profit, he is liable to honour the bill.