Discount Rate
What Does Discount Rate Mean?
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 explains Discount Rate
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]).
