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Discount RateIn Finance, one can define the discount rate as follows:
It is more interesting for the investor’s perspective. The discount rate is used in the concept of the Time value of money- determining the present value of the future cash flows in the discounted cash flow analysis. The time value of money means a fixed amount has different values at different times. For example, getting Rs.100 today or Rs would be better. 100 at the end of the year. The better choice would be getting Rs.100 today as you can earn a return if you invest it, and you will have the Rs.100 plus the return at the end of the year.
The discount rate can also be referred to as the rate at which the insurance and pension plan companies discount liabilities.
Interest RateInterest is the cost a borrower compensates to use someone else’s money.
Buy a 10- Year bond or make a Fixed Deposit in the bank, and you’ll get the interest. However, someone will pay you interest for using your money. Interest rates are directly proportional to the risk profile of the borrower. The interest rate will be higher if the borrower’s profile is considered risky; the interest rate charged on them will be higher.
Head To Head Comparison Between Discount Rate vs Interest Rate (Infographics)Below is the top 7 difference between Discount Rate vs Interest Rate:
Key Differences Discount Rate vs Interest Rate
The interest rate is the amount a lender charges to a borrower for the use of assets. The lenders here are the banks, and the borrowers are the individuals. Whereas, Discount Rate is the interest rate that the Federal Reserve Banks charge to the depository institutions and commercial banks on its overnight loans.
Interest rates depend on several factors, such as the Borrower’s creditworthiness, a risk associated with lending. The calculation of the discount rate involves considering the average rate at which one bank charges another bank for overnight loans.
In the concept of the Time value of money, the discount rate plays a crucial role in determining the present value of future cash flows in the discounted cash flow analysis. It is more interesting for the investor’s perspective. Whereas, Interest rates are calculated from the viewpoint of the Lenders.
The economy’s demand and supply impact interest rates, but they do not influence discount rates.
The lenders charge the Interest rate in the following two ways, i.e., Simple Interest and Compound Interest. Whereas the discount rate calculation is complex- Determining the present value of the future cash flows in the discounted cash flow analysis.
Head To Head Comparison Between Discount Rate vs Interest RateBelow are the topmost comparisons between Discount Rate vs Interest Rate
The Basis of Comparison
Interest Rate
Discount Rate
Meaning Lenders charge borrowers an interest rate for using assets. Discount Rate is the interest rate that the Federal Reserve Banks charges to the depository institutions and to commercial banks on its overnight loans.
Charged on Individuals/ Borrowers Depository institutions/ Commercial banks
Rates are Decided by Commercial banks Central Banks
Dependency Depend on a number of factors, such as the Borrower’s creditworthiness, the risk associated with lending, and the market interest rate. The central banks determine the discount rate, independent of the market rate of interest.
Usage Determining present value is not possible with discount rates. It can be used in determining the present value of future cash flows.
Perspective Based on the Market and focusing on the Lender’s point of View Focusing on the Investor’s Point of View
Economies Affected by Demand and supply in supply in the economy. Not Affected by Demand and Supply in Supply in the Economy.
ConclusionAfter examining the above information, Discount Rate vs Interest Rate is two different concepts. A discount rate is a broader Finance concept with multi-definitions and multi-usage. Whereas Interest rate has a narrow definition and usage, many things are to consider before determining the interest rates. Discount Rates vs Interest rates are related to the cost of money but in different ways. Sometimes, you have to pay to borrow money; then, it is a direct financial cost. In other cases, when you invest money in an investment that cannot be utilized in anything else, there is an opportunity cost. If you have an interest in Finance and want to work in the Financial Sector in the future, then you should know the difference between Interest rates and Discount rates.
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