Financial information always attracts readers and especially recently, Banktop.vn has received many questions. In which, the most concerned issue is about discount rate. So what is the discount rate? Impact like? What is the formula for calculating the discount rate?
Let's find out with banktop through the content of this article!
See more:
- What is equity?
- profit before tax and after tax
What is discount?
Discount in business is understood as a reduction in the listed price of a product/service of an enterprise corresponding to a certain percentage. Simply put, a discount is an allowance or price concession.
Discounts are given to entice buyers to place an order and then pay it in a timely manner. In the course of business, a discount can be thought of as a deduction in the price. The seller deducts the discount from the total or total price, and the buyer is obligated to pay the net amount.
What is a bank discount?
Bank discount is short-term credit of commercial banks.
In which, customers transfer ownership of valuable papers that have not yet been due to be paid to a commercial bank to receive an amount equivalent to the due value minus discount interest and fee commissions.
To put it simply, discounting is buying short-term papers with a lower value than their par value and paying them at their par value when they are due. In discounting, the ratio between the price paid and the nominal value of the valuable papers (bills or bonds) is the interest received on the loan in exchange for the security of the valuable papers.
Types of papers to be discounted
Branches of foreign banks and credit institutions that choose to discount negotiable instruments issued in Vietnam or issued abroad are transferred in Vietnam, including:
- Bill of exchange for debt collection
- Bill of exchange for debt receipt
- Czech
- Other types of negotiable instruments are discounted in accordance with the law
Foreign bank branches and credit institutions that choose to discount valuable papers include:
- State Bank Bills
- Government Bonds
- Government-guaranteed bonds
- Local Government Bonds
- Promissory notes, bills, certificates of deposit, bonds issued by credit institutions, foreign bank branches in accordance with regulations of the State Bank of Vietnam
- Promissory notes, bills, bonds issued by other organizations and discounted in accordance with current law
What is the discount rate?
The discount rate is the interest rate charged by the central bank (the State bank) on loans to commercial banks to meet their short-term or extraordinary cash needs. .
Discount rate is a familiar term for those who work in banking and finance, they will understand it very well.
Specifically, you can understand that it is the interest rate applied by the state bank when lending. However, the borrowers are not customers but commercial banks, which means that when operating, there will be cases where they need to borrow money from the central bank.
That is when the bank's cash reserve ratio cannot be guaranteed, then commercial banks will consider borrowing money to avoid customers withdrawing money.
In addition, you can also understand simply that the discount rate is a tool in monetary policy. It is an important base for both state-owned and commercial banks.
See more:
- What is principal income?
- What is a floating interest rate?
The most accurate formula for calculating discount rate
The discount rate can be calculated as:
- Funding cost
- Weighted Average Cost of Capital (WACC)
Cost of raising capital
The discount rate can be calculated using the cost of funding. This is the rate of return the investor wants to get back from the project. In other words, the discount rate is the cost of capital, or the opportunity cost of capital.
Eg: If you withdraw your savings with an interest rate of 5% to invest, you can calculate a discount rate of 5%.
weighted average cost of capital
WACC = the firm's average cost of capital.
Businesses have two main sources of capital:
- Commercial loan => cost of debt is the interest rate of the loan (1-tax)*interest rate; and,
- Shareholder's capital => cost of equity is the desired income of shareholders.
WACC can be calculated as the average cost of use of the above two sources of capital.
WACC = re * E/(E+D) + rD(1-TC)* D/(E+D)
In there:
- re: desired rate of return of shareholders
- rD: the creditor's desired interest rate
- E: the market price of the company's shares
- D: market price of the firm's debt
- TC: corporate income tax rate
re = [Div0(1+g)/P0] + g
In there:
- P0 is the stock price of the company at the base time
- Div0 is the dividend of the company's stock at the base time
- g: expected growth rate of dividends.
What is the difference between nominal interest rate and real interest rate?
How does the discount rate work?
Nature of discount rate clearly shows its important role. Specifically how you can find out through the following effects:
Impact of discount rate on commercial banks
The discount rate set by the central bank has major implications. Accordingly, first of all, for commercial banks, it is an important basis. Above all, banks always closely monitor and update the discount rate.
More precisely the discount rate directly affects the ratio of cash reserves from banks. It is the basis to help commercial banks decide to reduce or increase the reserve ratio.
Specifically, commercial banks always compare the discount rate with the market interest rate. If the discount rate is higher, the bank will not be able to let the reserve ratio be too low. Especially banks avoid the rate of reserves reaching the safe level. In particular, banks also tend to increase the reserve ratio to ensure that there is no risk when customers withdraw money.
Conversely, if the discount rate is equal or lower, the bank will be able to freely lend. Just stop at the minimum safe rate. Simply because at this time, if there is a shortage of cash, banks can completely borrow from the state bank. The interest rate the bank enjoys will not cause risks.
Refer: How to calculate the most detailed installment loan interest rate
Impact of the discount rate on the Central Bank
The impact of discounting on commercial banks is obvious. However, more importantly, it is an effective tool of the state bank.
Precisely the central bank will set the discount rate to regulate the money supply. Accordingly, if the bank wants to increase the money supply, it will reduce the lending interest rate, on the contrary, if the bank wants to decrease the money supply, it will increase the discount rate.
Simply because when the discount rate increases, commercial banks will reduce lending.
What is adjustable interest rate?
Assess the advantages and disadvantages of discounting in banks
Advantage
- This is a low-risk business, the bank's ability to recover debts is very certain.
- Discount is a simple form of credit, less hassle for banks, because the loan procedure and process is quite simple.
- Discounting does not let the bank's capital "freeze".
- The discount period is short (less than 90 days) and the commercial bank can easily apply for rediscount of the draft at the Bank in need of capital.
- Money granted to the customer when the discount is transferred to the customer's deposit account. So it forms a source of capital for the bank.
Defect
- Banks sometimes have to discount forged drafts, which means that the drafts are not actually from a commercial relationship, issued by some individuals arbitrarily for the purpose of defrauding the bank.
- The person responsible for paying the valuable papers becomes insolvent before and when the valuable papers are due for payment.
Some other definitions of discount
What is a bank discount?
Bank discount is short-term credit of commercial banks.
In which, customers transfer ownership of valuable papers that have not yet been due to be paid to a commercial bank to receive an amount equivalent to the due value minus discount interest and fee commissions.
What is a discount loan?
Discount lending is a credit facility from the central bank that lends money to commercial banks to meet short-term cash needs or unusual needs of commercial banks. This loan will charge a discount rate.
What is L/C discount?
L/C discount is a form of credit extension of the Bank to the customer, which means that the Bank will buy back and may recourse the set of documents according to the export L/C before the payment is due. The purpose of this discount is to meet the capital needs of the business, supplement working capital after delivery in export business.
In L/C discount, the discount rate, discount rate will be different depending on the customer, type of L/C.
What is a bill of exchange?
Draft discounting is the granting of credit by the Bank to customers. The Bank redeems and has recourse to the Bill of Lading before the maturity date.
What is a discount bond?
A discount bond is a bond that is issued at a price lower than the face value of the bond. At this time, the discount bond is called a prepaid bond. A discount bond can refer to a bond that is currently trading for less than its face value in the market.
Bonds that sell for significantly less than par, or at 20% or more, are called deep discount bonds. Discount bonds are bought and sold from institutional and individual investors.
What is payment discount?
Payment discount is a percentage discount on the early payment amount of the customer at the time of payment. In simple terms, payment discount is the amount of money the seller reduces to the buyer, because the buyer pays the goods before the contract period.
What is the discount rate?
The discount rate is calculated on the amount stated on the commercial paper or valuable papers before the payment term. The rate of rediscount rate depends on the solvency of the obligor to pay the amount on the commercial paper or valuable papers.
The rediscount interest rate applies to the State Bank and credit institutions that re-purchase commercial papers and valuable papers.
What is rediscount?
Rediscounting is the practice by which a commercial bank or central bank applies the redemption of mature and reliable valuable papers owned by other banks at a certain rediscount rate. These valuable papers have been discounted and rediscounted by banks in the secondary market.
What is Trade Discount?
Trade discount is a business discount for customers to buy in bulk.
What is commercial paper discount?
Discounting commercial paper is a form of credit of commercial banks, made by the bank buying back unmatured commercial paper from customers. In other words, this is the sale of commercial paper to the bank to quickly collect money at a price lower than the commercial paper price. The feature of this credit is that the interest is paid immediately upon receipt of capital.
Conclude
Discount rate what? What are its effects? We hope that through our explanations above, you will understand the problem clearly. In addition, if you need more detailed advice on financial information, please contact Banktop
Information edited by: banktop.vn
Post a Comment
Post a Comment