- This topic has 5 replies, 2 voices, and was last updated 1 year ago by
.
- Posts
Hello sir, i am totally lost with these terms used interchangeable or are they the same thing so could you please explain them precisely?
What is the difference between interest rate, rate of return and discount rate?
Is it true that interest rate is the nominal interest rate used in the sense of borrowing and investment to let the borrower and lender how much they have pay?
Secondly, rate of return is the return on investment only (no borrowing!)?
Thirdly, discount rate is actually the interest rate used to discount the deferred consideration in order to arrive at present value?
Lastly, The interest rate values chart given at the beginning pages of kaplan book for present value and annuity rates are actually discount rates or interest rates to be precise. And do we use them for discounting the future cashflows only likewise in the present value calculation. (Please explain this one in detail?)
Have you watched my free lectures on all of this, because it is all explained with examples?
The discount rate used in calculating present values is the rate of interest that the company is having to pay on its borrowing. In Paper MA you are told the rate of interest (in later exams you can be asked to calculate it but this is not relevant for Paper MA).
For Paper MA, the rate of return is the accounting rate of return which is nothing to do with the interest rate.
The distinction between nominal and ‘real’ interest rates is not examinable until Paper FM.
I couldn’t get the complete understanding of these issues. Could you please explain it to me?
1) Discount rate is the interest rate that company pay on its borrowing so if we remove the interest element then we will get the Present value which helps us decide how much we have to pay today?
2) Discount rate can be called an interest rate because the time factor is involved in that. That’s why it is discount rate?
3) BUT interest receive on investments is actually the rate of return (not the discount rate) that company receives by investing?
4) Investors can use Present value for both the borrowing and investment prospects but Future value involves only used for investment?
5) I find it problematic to understand but hoping you would clear that. The present values chart given at the beginning of the kaplan book are actually discount rates (and not the interest rates). So we use them for discounting the future cashflows only to convert them into present cash flow?
6) What is the difference between these three formulae Present values, annuity values and perpetuity. And when to use them?
1, 2, ans 3. Correct
4. We do not use future values in Paper MA.
5. The tables you refer to are not the discount rates, they are the discount factors. They are a faster way of discounting at the interest rate than using the formulae.
6. I explain this in detail, with examples, in my free lectures.
Thanks for your reply SIR.
Sorry if I go a bit off-topic here but it is essential to know for my understanding. I’d be happy if i get the answers 🙂
4. I know it is not part of paper MA BUT we use future values for investment prospects only because it cannot be used for borrowing like in leasing etc.
5. I will go little technical here. The discount factor of interest 10% after one-year would be 0.909 (in percentage term 9.09%) but what exactly is causing it?
It is correct to say that interest is reduced merely due to inflation effect. That’s why we will get lesser amount in future because our interest is decreased (similarly explained by Fisher equation).
6. I watched your lecture but pardon me English is not my first language.
(i) Present value is the current amount of future money in today’s term?
(ii) Annuity value is the calculated when the payment is made based on yearly term like we have to make payments as the end of each year?
(iii) Perpetuity is calculated when the payment or income is paid or received forever. We assume that we will usually receive the money in future unceasingly which is in reality untrue!
7. Is it true that time factor will decrease the Interest rate over time because the inflation will come in conflict with it. Inflation will directly affect the nominal interest rate which will affect the real interest which is exactly explained by Fisher equation?
8. For example, 10% interest rate will be 9.09% in one year’s time and lesser in future but what factors affect this?
- The topic ‘Interest rate and discount rate’ is closed to new replies.