Discount rates

It would be very unusual to have to deal with 6 monthly interest. However, if you do have to then it depends on the interest rate as to whether you need to use the formulae or whether you can use the tables. If the interest rate is given as an annual percentage then you need to use the formulae (which are printed at the top of the discount tables). So if, for example) is it 10% per year and you want to discount for 6 months then the discount factor is (1/1.1)^(1/2) (and something to the power of (1/2) is the same as taking the square root) If, on the other hand, the rate is given as a six-monthly rate (and is a whole percentage) then you can use the tables as normal. For example, if the interest rate is 5% every six months and there is a six-monthly annuity for 5 years. Then it means there are 10 payments in total and you can use the normal annuity factor for 10 years at 5% per year. (Although we usually think of the tables as being all in year, it is better to think of them as periods. In my example there would be 10 periods with interest at 5% per period.) Again, however, it is very very unusual to be expected to do much if any discounting for other than yearly periods.

There is a need for such calculation in the question Arnbrook JUN 06. The information is as follows: initially it is 5.7% and then moves to 6.2% in six months. How to calculate the discount rate for 0-6 months 6-12 months 12-18 months 18-24 months.

It is as I wrote before. for 6 months ( 1/2 years) at 5.7% it is (1/1.057)^(1/2) = 0.973 for 12 months at 6.2% (1 year) it is (1/1.062) = 0.942 for 18 months at 6.2% ( 1/5 years) it is (1/1.062)^(3/2) = 0.913 for 24 months at 6.2% (2 years) it is (1/1.062)^2 = 0.887 and so on However this is very unlikely to be needed in the exam. Arnbrook is the only time I remember it being asked (and it was 10 years ago and two examiners ago!)

Thank you! Now I understand. In the Kaplan exam kit the discount rates were calculated by interpolating the two rates, which was confusing for me. Now it's clear.

I am pleased that it is clear now :-)

Hi dear sir, Pls provide guidance on below: 1) what is unwinding? 2) is discount rate same as cost of capital? 3) what is the relationship between discount rate and finance cost?

Unwinding is something asked in Paper SBR (was P2), and not in Paper AFM. I suggest that you ask in the SBR Ask the Tutor Forum :-)