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Uploaded on on May 14, 2021

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The discount rate is a financial term that can have two meanings. In banking, this is the interest rate that the Federal Reserve charges banks for overnight loans. Despite its name, the discount rate is not been reduced. A comprehensive proposal for the use of interest can be used to reserve funds for financing. During major financial crises, both Feds can reduce the discount rate – and extend the loan time. In investment and accounting, the percentage of discount the rate of return is used for the accrued value of how much future cash flows cost today. If you need help understanding this or any other financial concept, consider working with a financial advisor.

Discount Rate at the Federal Reserve

For example, the discount of interest income, if you take into account the financial position of the new one, is the one that is reported before the discount of interest in the Federal Reserve System. This is the rate, which the Fed charges on commercial banks in the short-term loans of 24 hours or less.

Sometimes banks borrow money from the Fed to prevent liquidity problems or to cover funding shortfalls. These loans come from one of the 12 regional banks in the Federal Reserve.

Banks use these loans sparingly, as loans from other banks usually come with lower interest rates and less collateral. Meanwhile, the Fed’s demand for money may resolve as a sign of weakness that banks want to avoid. (Since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Fed must publicly disclose the names of the banks that borrow from the discount window and the loan amount.)

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Banks that borrow from the Fed fall into three discount programs or “discount windows.”

Primary credit, that gives overnight loans to banks that are in good financial shape.

Secondary credit, which lends at an interest rate higher than the base interest rate to banks, which do not meet the conditions of the primary loan.
Seasonal loan for banks with seasonal needs on-site such as agricultural or resort communities.

Who Sets The Discount Rate?

The board of directors across the regional Federal Reserve Bank an interest rate on primary credit loans every 14 days. The Board of Governors of the Federal Reserve then approves a discount rate that looks awfully similar in each region.

As of October 31, 2019, the basic rate was 2.25%, and the secondary rate, which should be 50 basis point higher, is 2.75%. Seasonal floating rate interest rate is based on market conditions and is the average interest rate resistance on federal funds and interest on quarterly certificates of deposit (CDs).

Discounted Rate of Return

The discounted rate of return – called more the discount rate and unrelated to the above definition – is the expected rate of return on investment. Also known as the cost of capital or the required rate of return, it estimates the current value of an investment or business based on the expected future cash flow.

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