interest rates, discount factors and rates of discounts

explain how interest rates relate to discount factors

top one: r is the interest rate (to get from present to future value)

REARRANGED TO MAKE

bottom one: r is the discount rate (to get from future to present value)

what’s one period discount factor then (not rate) and what is its symbol

so C₁ × 1 period discount factor = C₀

how can we define a discount factor

the present value of a £1 payment made in one period’s time

explain that concept using C₁ = 1, with a discount rate of 10%

.

so then what is a rate of discount

the amount we take off the future amount to work out its present value

it’s ‘d’ in the formula above

explain that concept again using C₁ = £1

if the future value is £1, and the present value is £0.91, then we have had to take off 9% of the future value to discount it to the present value

as you can see that’s different from the interest (and therefore discount) rate of ‘r’ that was 10% to get from 0.91 to 1

an interest/discount rate (r) is applied to the ________________, while the rate of discount (d) is applied to the _________________

first one: PRESENT VALUE (principal)

second one: FUTURE VALUE

where are rates of discount mostly/often used

in some money markets (but they are sometimes confusingly called discount rates - be careful!!)