The terms Interest rate and Discount rate are confusing as both charge rates. Most people misunderstood it as the same term.
The Discount rate is the interest rate the central bank gives the commercial bank. The minimum interest rate offered is by the central bank.
And Interest rate here is the money or some other service that the lender gives to the borrower for which the lender charges some percentage of that money yearly or monthly as the interest rate.
Both Interest rate and Discount rate are different as the Discount rate is imposed on big corporates and companies, while the Interest rate is for all public and private sectors.
Key Takeaways
- Interest rate refers to the percentage charged by lenders for the use of their money, while discount rate is the interest rate used to discount future cash flows.
- The interest rate is the cost of borrowing money, while the discount rate is the rate used to determine the present value of future cash flows.
- The interest rate can be fixed or variable and can be influenced by market conditions, while the Federal Reserve sets the discount rate and is used for financial analysis purposes.
Interest Rate vs Discount Rate
The difference between the discount rate and Interest rate is that the Interest rate is the amount that is taken from the borrower yearly or monthly by the lender for the service they have provided.
On the other hand, the Discount rate is a charge the central bank imposes on commercial banks on its shortest-term loans.
The interest rate is the amount taken from the borrower by the lender for the service they have provided. But the Interest rate is dependent on the effective rate of interest.
The interest rate focuses on an individual for personal use or corporates for public use.
On the other hand, the Discount rate is a charge taken by the central bank to the commercial bank. It does not get affected by the effective rate of interest.
And it calculates the current value of the net amount of cash that the commercial bank has returned.
Comparison Table
| Parameters of Comparison | Interest Rate | Discount Rate |
|---|---|---|
| Definition | It is the loan that the lender gives to the borrower, so the lender charges some percentage of that amount yearly or monthly as the interest rate. | It refers to the interest rate that calculates the current value of the net cash that the commercial banks return. |
| Dependency | It depends on the effective rate of interest. | It does not depend on the effective rate of interest. |
| Rates are decided by | Commercial banks. | Central bank. |
| Viewpoint | It is mainly focused on the lender’s viewpoint. | It is mainly focused on the investor’s viewpoint. |
| Uses | It is not used to calculate the net amount of cash that commercial banks return. | It calculates the net amount of cash that commercial banks return. |
What is the Interest Rate?
Interest rate is the money or some other service the lender gives to the borrower; the lender charges some percentage of that money yearly or monthly as the interest rate.
It is charged monthly or annually depending on the loan type and the amount loaned to the borrower. The interest rate relies on the effective interest rate.
It shows that the loan amount depends on the borrower’s reliability.
Commercial banks decide interest rates, and it differs from bank to bank. There are two types of Interest rates: Compound interest and Simple interest.
Simple interest remains the same every year, but Compound interest changes as the amount charged previously is added to the principal amount.
What is Discount Rate?
The discount rate is the minimum interest rate that the central bank provides. It calculates the current value of the net amount of cash that the commercial banks return.
Simply put, it is the amount the central bank charges on the institutions or commercial banks on its shortest-term loans as interest.
The discount rate does not depend on the effective interest rate and is mainly concerned with the investor’s viewpoint. It does not differ from bank to bank.
In the Discount rate, the companies’ demand, supply, and value do not affect Discount rates. In the Discount rate, the fixed amount of money plays different roles occasionally.
It is charged to investing institutions or commercial banks. The Discount rate does not get affected by the effective rate of interest.
Main Differences Between Interest Rate and Discount Rate
- The discount rate is the central bank’s interest rate on commercial banks’ shortest-term loans. In contrast, interest is the loan the lender gives the borrower; the lender charges some percentage of that money yearly or monthly as the interest rate.
- The commercial banks decide the interest rate, and the Discount rate is determined only by the central bank.
- The change in the effective rate of interest affects the interest rate. But the effective interest rate changes do not affect the discount rate.
- In the Interest rate, the main focus is on the lender’s viewpoint, but in the Discount rate, the investor’s viewpoint is given more value.
- The discount rate is used to find the current value of the net cash returned by the commercial banks. But it is not calculated by the Interest rate.
- https://www.jstor.org/stable/1821281
- https://www.sciencedirect.com/science/article/pii/S0095069684710126
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