Relationship between Interest and Discount14th February 2020
The rate charged by the Reserve Bank from the commercial banks and the depository institutions for the overnight loans given to them. The discount rate is fixed by the Federal Reserve Bank and not by the rate of interest in the market.
Also, the discount rate is considered as a rate of interest which is used in the calculation of the present value of the future cash inflows or outflows. The concept of time value of money uses the discount rate to determine the value of certain future cash flows today. Therefore, it is considered important from the investor’s point of view to have a discount rate for the comparison of the value of cash inflows in the future from the cash outflows done to take the given investment.
If a person called as the lender lends money or some other asset to another person called as the borrower, then the former charges some percentage as interest on the amount given to the later. That percentage is called the interest rate. In financial terms, the rate charged on the principal amount by the bank, financial institutions or other lenders for lending their money to the borrowers is known as the interest rate. It is basically the borrowing cost of using others fund or conversely the amount earned from the lending of funds.
There are two types of interest rate:
- Simple Interest: In Simple Interest, the interest for every year is charged on the original loan amount only.
- Compound Interest: In Compound Interest, the interest rate remains same but the sum on which the interest is charged keeps on changing as the interest amount each year is added to the principal amount or the previous year amount for the calculation of interest for the coming year.