Discount rate


Discount rate
For the fees charged to merchants for accepting credit cards, see Discount Rate under Merchant Account.
For discount rate as a term in investment financing, see Discounted cash flow
German central bank discount interest rates

The discount rate can mean

  • the annual effective discount rate, which is the annual interest divided by the capital including that interest; this rate is lower than the interest rate; it corresponds to using the value after a year as the nominal value, and seeing the initial value as the nominal value minus a discount; it is used for Treasury Bills and similar financial instruments

Contents

Annual effective discount rate

The annual effective discount rate is the annual interest divided by the capital including that interest, which is the interest rate divided by 100% plus the interest rate. It is the annual discount factor to be applied to the future cash flow, to find the discount, subtracted from a future value to find the value one year earlier.

For example, suppose there is a government bond that sells for $95 and pays $100 in a year's time. The discount rate according to the given definition is

\frac{100-95}{100} = 5.00\%

The interest rate is calculated using 95 as its base:

\frac{100-95}{95} = 5.26\%

For every annual effective interest rate, there is a corresponding annual effective discount rate, given by the following formula:

d = \frac{i}{1+i}\approx i-i^2

or inversely,

i = \frac{d}{1-d}\approx d+d^2

where the approximations apply for small i and d; in fact i - d = id.

See also notation of interest rates.

Business calculations

Businesses need to consider the discount rate when deciding whether to spend some of their profits on buying a new piece of equipment, or whether to give the profit back to their shareholders. In an ideal world, they would only buy a piece of equipment if the shareholders would get a bigger profit later. The amount of extra profit that a shareholder requires in the future in order to prefer that the company buy the equipment rather than giving them the profit now is based on the shareholder's discount rate. There is a widely used way of estimating shareholder's discount rates using share price data. It is known as the capital asset pricing model. Businesses normally apply this discount rate to their decisions about purchasing equipment by calculating the net present value of the decision

See also

References

External links


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Look at other dictionaries:

  • discount rate — n 1: the interest on an annual basis deducted in advance on a loan 2: the interest levied by the Federal Reserve for advances and rediscounts Merriam Webster’s Dictionary of Law. Merriam Webster. 1996 …   Law dictionary

  • discount rate — n. 1. DISCOUNT (n. 3) 2. the rate at which the Federal Reserve Banks discount or rediscount securities offered by member banks …   English World dictionary

  • discount rate — discount .rate n [C usually singular] the interest rate that a country s ↑central bank charges to other banks …   Dictionary of contemporary English

  • discount rate — discount ,rate noun count BUSINESS the rate of interest that The Federal Reserve charges another bank that borrows from it …   Usage of the words and phrases in modern English

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  • discount rate — Finance. 1. the rate of interest charged in discounting commercial paper. 2. the interest rate charged by Federal Reserve Banks on loans to their member banks, usually against government securities as collateral. 3. the rediscount rate. [1925 30] …   Universalium

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  • Discount Rate — 1. The interest rate that an eligible depository institution is charged to borrow short term funds directly from a Federal Reserve Bank. Different types of loans are available from Federal Reserve Banks and each corresponding type of credit has… …   Investment dictionary

  • Discount rate — Taux d escompte NB : À ne pas confondre avec taux d actualisation. Le taux d escompte est un taux d intérêt utilisé sur le marché monétaire, pour les prêts à très court terme (quelques jours). Le terme escompte caractérise la particularité… …   Wikipédia en Français

  • discount rate — 1) The hurdle rate of interest or cost of capital rate applied to the discount factors used in a discounted cash flow appraisal calculation. The discount rate may be based on the cost of capital rate adjusted by a risk factor based on the risk… …   Big dictionary of business and management


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