Discount rate
The rate a future amount is shrunk by to express it in today's money. It is the return available elsewhere on something equally risky.
Where you will meet it
Discount rate appears in 33 learning outcomes on the CFA syllabus. A few of them:
- Outline the main families of equity valuation model and what each gains or gives up
“They rest on fundamentals but are highly sensitive to growth and discount rate assumptions.”
- Explain defined benefit pension obligations and how they flow through the statements
“The obligation depends on assumptions management sets: the discount rate (anchored to high-quality corporate bond yields), expected salary growth and mortality.”
- Contrast current yield with yield to maturity
“Yield to maturity is the single discount rate that makes the present value of all the bond's cash flows equal its price, so it takes in the coupon, the capital gain or loss to redemption and the timing of both.”
- Work out what one cash flow is worth today
“The discount rate is the return available on an equivalent alternative, so discounting asks what sum today would grow into the promised amount.”
Learn it properly
- NPV vs IRR: which capital budgeting rule to trust
- Time value of money explained: present value, future value and annuities
Practise it
Practise discount rate until it is automatic: questions that explain every wrong option.
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