DEFINITION of 'Discount Rate'
The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve Bank’s discount window. The discount rate also refers to the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows. The discount rate in DCF analysis takes into account not just the time value of money, but also the risk or uncertainty of future cash flows; the greater the uncertainty of future cash flows, the higher the discount rate. A third meaning of the term “discount rate” is the rate used by pension plans and insurance companies for discounting their liabilities.
INVESTOPEDIA EXPLAINS 'Discount Rate'
The Fed’s Discount Rate is an administered rate set by the Federal Reserve Banks, rather than a market rate of interest. Use of the Fed’s discount window soared in late 2007 and 2008, as financial conditions deteriorated sharply and the Federal Reserve took steps to provide liquidity to the financial system. Discount window borrowing soared to a record $111 billion at the height of the global financial crisis in October 2008, while the Federal Reserve’s board of governors set the discount rate at a postWW II low of 0.5% on Dec. 16, 2008.
A simple explanation of the discount rate used in DCF analysis is as follows. Let's say you expect $1,000 in one year. 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 interest rate. Assuming a discount rate of 10%, the $1,000 in a year's time would be equivalent to $909.09 to you today (1,000 / [1.00 + 0.10]). If you expect to receive the $1,000 in two years, its present value would be $826.45.
What is the appropriate discount rate to use for a project? Many companies use their weighted average cost of capital (WACC) if the project's risk profile is similar to that of the company. But if the project’s risk profile is substantially different from that of the company, the Capital Asset Pricing Model (CAPM) is often used to calculate a projectspecific discount rate that more accurately reflects its risk.
VIDEO

Overnight Rate
The interest rate at which a depository institution lends immediately ... 
Federal Reserve Bank
The central bank of the United States and the most powerful financial ... 
Federal Funds Rate
The interest rate at which a depository institution lends funds ... 
Bank Reserve
Bank reserves are the currency deposits which are not lent out ... 
Federal Open Market Committee  ...
The branch of the Federal Reserve Board that determines the direction ... 
Discounted Cash Flow  DCF
A valuation method used to estimate the attractiveness of an ...

What happens if the Federal Reserve lowers the reserve ratio?
If the Federal Reserve decides to lower the reserve ratio through an expansionary monetary policy, commercial banks are required ... Read Full Answer >> 
How can I use the Dividend Discount Model (DDM) effectively for a stock with fluctuating ...
The dividend discount model (DDM), also known as the Gordon growth model, assumes a stock is worth the summed present value ... Read Full Answer >> 
What's the difference between the prime rate and the discount rate?
Both the prime rate and discount rate are used in the financial system and set in the United States by the Federal Reserve ... Read Full Answer >> 
How is convertible bond valuation different than traditional bond valuation?
Convertible bonds have features of equity securities since they can be conditionally converted into shares. This makes them ... Read Full Answer >> 
How is perpetuity used in determining the intrinsic value of a stock?
Investors are often interested in determining intrinsic values of the stocks, bonds or other securities as they consider ... Read Full Answer >> 
Why is the initial value of a forward contract set to zero?
Forward contracts are buy/sell agreements that specify the exchange of a specific asset and on a specific future date but ... Read Full Answer >> 
What impact does economics have on government policy?
Governments may make policy changes in response to economic conditions. Government regulation of the economy is frequently ... Read Full Answer >> 
How do I calculate a discount rate over time, using Excel?
The discount rate is either the interest rate that is used to determine the net present value (NPV) of future cash flows ... Read Full Answer >> 
How do central banks impact interest rates in the economy?
In the United States, the central bank – the Federal Reserve (the Fed) – is tasked with maintaining a certain level of stability ... Read Full Answer >> 
What value metrics are best for analyzing companies in the metals and mining sector?
Discounted cash flow (DCF) analysis is often applied to companies in the mining business because accurate evaluation of a ... Read Full Answer >> 
What is the formula for calculating net present value (NPV) in Excel?
Net present value (NPV) is a popular measure of profitability used in corporate budgeting to assess a given project's potential ... Read Full Answer >> 
How does the Federal Reserve's set discount rate affect my personal finances?
The set discount rate of the Federal Reserve Bank affects personal finance by being the determining factor of all other interest ... Read Full Answer >> 
What is the difference between yield to maturity and the spot rate?
Bonds are marketable and relatively liquid securities, and there are several different accounting methods for discounting ... Read Full Answer >>

Economics
Understanding Interest Rates: Nominal, Real And Effective
Interest rates can be broken down into several subcategories that incorporate various factors such as inflation. Smart investors know to look beyond the nominal or coupon rate of a bond or loan ... 
Fundamental Analysis
Discounted Cash Flow Analysis
Find out how analysts determine the fair value of a company with this stepbystep tutorial and learn how to evaluate an investment's attractiveness for yourself. 
Investing Basics
How Banks Set Interest Rates On Your Loans
On the face of it, figuring out how a bank makes money is a pretty straightforward affair. A bank earns a spread on the money it lends out from the money it takes in as a deposit. The net interest ... 
Investing Basics
DCF Valuation: The Stock Market Sanity Check
Calculate whether the market is paying too much for a particular stock. 
Bonds & Fixed Income
Understanding Interest Rates, Inflation And The Bond Market
Get to know the relationships that determine a bond's price and its payout. 
Investing Basics
Understanding The Time Value Of Money
Find out why time really is money by learning to calculate present and future value. 
Personal Finance
How The U.S. Government Formulates Monetary Policy
Learn about the tools the Fed uses to influence interest rates and general economic conditions. 
Personal Finance
How The Federal Reserve Manages Money Supply
Find out how the Fed manages bank reserves and this contributes to a stable economy. 
Investing Basics
Interest Rates And Your Bond Investments
By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it. 
Mutual Funds & ETFs
ETF Analysis: Select Sector Financial SPDR
Find out more about the Financial Select Sector SPDR Fund, the characteristics of the exchange traded fund, and the suitability of fund.