discount rate

1. The interest deducted in advance in purchasing, selling, or lending a commercial paper.
2. The interest rate charged by a central bank on loans to its member banks. A change in the discount rate is usually followed by similar changes in the interest rates charged by banks and money markets.

1. The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank.

2. The interest rate used in determining the present value of future cash flows.

Investopedia Says:
1. This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. The Federal funds discount rate is one of two interest rates the Fed sets, the other being the overnight lending rate, or the Fed funds rate.

2. For example, let's say you expect $1,000 dollars in one year's time. To determine the present value of this $1,000 (what it is worth to you today) you would need to discount it by a particular rate of interest (often the risk-free rate but not always). Assuming a discount rate of 10%, the $1,000 in a year's time would be the equivalent of $909.09 to you today (1000/[1.00 + 0.10]).

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1. Rate charged by Federal Reserve Banks for loans at the Federal Reserve Discount Window. The discount rate is set by each Federal Reserve Bank and approved by the Federal Reserve Board of Governors in Washington. Each Reserve Bank submits its own rate to the board, which then either approves the rate or denies it. The discount rate is not necessarily the same across all 12 Federal Reserve Banks. Occasionally, one or more of the district Fed banks has insisted on a different rate than other Fed banks. This situation could persist for several weeks, although in recent years the Reserve Banks have tended to fall into line with a uniform discount rate, reflecting the emergence of a national market for bank credit. The discount rate is one of the policy tools the Federal Reserve Board employs to carry out monitory objectives; the others are Open Market Operations and Reserve Requirements. As of March 31, 1980, when the Monetary Control Act of 1980 became law, all depository financial institutions holding transaction accounts were able to borrow at the discount window.

2. Bank Discount Rate quoted by banks when they accept acceptances and bills of exchange. The best names, those holding prime paper, qualify for the lowest rates.

1. A Compound Interest rate used to convert expected future income into a present value. See Capitalization Rate, Present Value of Annuity, Present Value of One.
Example: A discount rate of 10% applied to a $100 sum expected to be received in one year results in a present value of $90.90. (The Present Value of One for one year is 0.909.)

2. The rate charged member banks who borrow from the Federal Reserve System. Same as Rediscount Rate.
Example: See Rediscount Rate.

For more information on discount rate, visit Britannica.com.

The rate of interest charged by the Federal Reserve System on loans it makes to the banking system.

For the interest rate charged to banks for borrowing short-term funds directly from the Federal Reserve, see discount window.

German central bank discount interest rates

The discount rate is an interest rate a central bank charges depository institutions that borrow reserves from it.

The term discount rate has two meanings:

• the same as interest rate; the term "discount" does not refer to the meaning of the word, but to the purpose of using the quantity, such as computations of present value, e.g. net present value or discounted cash flow

• 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 1 Annual effective discount rate 2 Business calculations 3 See also 4 References 5 External links

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 the given definition is

The interest rate is calculated using 95 as its base:

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

or inversely,

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

• Discounting
• Discounted Cash Flow
• Discount window
• Discount
• Social discount rate
• Ramsey growth model
• compare and contrast with Fed Funds

References

External links

• Definition of the "Discount Rate" from the Federal Reserve Board's official site
• Instruments of the Money Market: Table of Contents
• The Discount Rate and Theories of the Great Depression, R. L. Norman, Jr.
• Instruments of the Money Market: Chapter 3 - The discount window
• Using the Build Up procedure for equity discount rate calculation.
• Discount Rate Definition from the Finance and Banking Dictionary

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