What it means
In the money markets, a bill is a short-term promise to pay a fixed sum on a set date, and it is sold at a discount to that sum. A discount house specialised in buying these bills with money borrowed from banks, earning the gap between the interest it paid and the return the bills produced.
It was a specialist trading business built on borrowing short and lending short. The historical importance of the discount houses came from their role as a buffer.
Commercial banks lent them money on a day-to-day basis, and when banks needed cash, the central bank would deal through the discount houses rather than directly with every bank. This shielded the banks from the central bank and helped keep the money market orderly.
Over time, changes in regulation and the growth of other money market players reduced their role. In the United Kingdom, the traditional discount houses were gradually absorbed into larger banking groups or changed their business.
The function they performed, however, remains part of how modern money markets operate. For a finance reader, the term matters mostly for historical context and for understanding how short-term funding works.
Treasury teams that invest cash in bills and commercial paper are doing, on a smaller scale, what discount houses did: buying securities at a discount and taking the return as time passes. A nuance is that the same words are also used for shops.
In everyday retail, a discount house is a store that sells goods at lower prices than traditional retailers by keeping costs and margins thin. Always check the context before assuming which meaning is intended.
Understanding the older model still helps with modern funding questions. Any business that relies on short-term borrowing to hold longer-lasting assets faces the same exposure the discount houses did, namely that funding costs can rise before the assets earn more.
Treasury policies that limit that gap owe a good deal to lessons learned in this part of the market.
In practice
Real-world examples.
Example
A discount house borrows overnight money from commercial banks and uses it to buy treasury bills. It earns a small margin on a very large volume. The business depends on keeping its funding costs below the return on the bills.
Example
A central bank wants to inject cash into the money market. In the historical arrangement, it buys bills from discount houses, which passes cash to the banking system. Commercial banks then find it easier to meet their daily needs.
Example
A shopper visits a discount house that sells branded household goods at 20% below the high street price. The store keeps costs low by using simple premises and buying in bulk. Its profit comes from volume rather than margin.
Formula
Calculation
Purchase price of a bill = face value x (1 - discount rate x days / 360)
A discount house buys a 90-day bill with a face value of $1,000,000 at a discount rate of 4%, using a 360-day year. The discount is $1,000,000 x 0.04 x 90 / 360 = $10,000. The purchase price is $1,000,000 - $10,000 = $990,000. If the house funds the purchase with borrowing at 3.2% for 90 days, the interest cost is $990,000 x 0.032 x 90 / 360 = $7,920, leaving a gross margin of $10,000 - $7,920 = $2,080.Case study
Seen in the real world.
Whitmore and Dale is an illustrative, fictional discount house that, in a past era, held $400,000,000 of bills funded by overnight loans from banks. It earned about 0.25% more on the bills than it paid on the loans, or roughly $1,000,000 a year before costs.
One year a sudden rise in short-term interest rates pushed funding costs above the return on the bills it held. The firm lost $600,000 in a single month because its assets were locked into longer bills while its borrowing repriced every day.
The directors responded by matching the maturity of its bills more closely to its funding. The illustrative lesson is that a thin margin business needs tight control of the gap between when its assets and liabilities reprice.
Watch out
Common mistakes.
- Assuming a discount house is always a shop, when in finance the term refers to a dealer in short-term bills.
- Thinking a discount house lends to consumers, when it funds itself in the money market and invests in short-term securities.
- Ignoring the interest rate risk in the business, when a small rise in funding costs can erase a very thin margin.
Questions
People also ask.
What did UK discount houses do?
They bought treasury and commercial bills with money borrowed from banks, and acted as intermediaries between the central bank and the banking system.
Do discount houses still exist?
The traditional specialist firms have largely disappeared or been absorbed by larger banks, though their function continues within modern money markets.
What is a bill?
A short-term security, usually lasting a year or less, that is sold below face value and repaid at face value on the due date.
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