Future Business Leaders of America (FBLA) Agribusiness Practice Test

What defines discount interest?

1. Interest added retroactively at payment

2. Interest deducted from the principal at the loan's origination

3. Interest calculated based on current market rates

4. Interest that is paid in cash upfront

The correct answer is: Interest deducted from the principal at the loan's origination

Discount interest is defined as the interest that is deducted from the principal at the loan's origination. This means that when a borrower takes out a loan, the lender calculates the total amount of interest that will be charged over the life of the loan and subtracts this amount from the loan's principal before disbursing the funds to the borrower. As a result, the borrower receives an amount that is less than the total repayable amount, which includes both the principal and the discount interest. This method is particularly common in short-term loans and notes where the interest is effectively prepaid. By using discount interest, lenders can efficiently ensure that they receive the interest cost upfront while the borrower benefits by securing the loan immediately, even if they receive less in cash than they are obligated to repay later. In contrast, other options present different concepts of interest calculation. For example, interest added retroactively at payment refers to how some loans accrue interest over time and might alter the total payable amount upon repayment, while interest calculated based on current market rates pertains to variable interest rates and does not reflect the nature of discount interest. Lastly, paying interest in cash upfront describes a different arrangement and does not encapsulate the nature of how discount interest functions in relation to the loan principal.