Discount factor
The present value of one unit paid on a given date: 1 ÷ (1 + spot rate) raised to the number of periods. Multiplying a cash flow by it discounts that cash flow.
Where you will meet it
Discount factor appears in 7 learning outcomes on the CFA syllabus. A few of them:
- Tell apart what a swap is worth and what it is priced at
“Using discount factors for each payment date, the swap rate is (1 - final discount factor) divided by the sum of the discount factors.”
- Explain the pricing of interest rate swaps, and work out their no-arbitrage value and say what it means
“A swap's fixed leg is priced like a par bond: the swap rate is (1 − final discount factor) ÷ sum of discount factors for the payment dates.”
- Explain the pricing of currency swaps, and work out their no-arbitrage value and say what it means
“Each fixed rate is set like a swap rate in its own currency: (1 − final discount factor) ÷ sum of discount factors, using that currency's curve.”
- Explain the pricing of equity swaps, and work out their no-arbitrage value and say what it means
“Its fixed rate equals the plain interest rate swap rate for the same dates: (1 − final discount factor) ÷ sum of discount factors, because the equity leg resets to notional at each settlement.”
See also
Practise it
Practise discount factor until it is automatic: questions that explain every wrong option.
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