Discount Rate of Fed
The Federal Reserve discount rate is how much the Fed charges its member banks (there are twelve regional Federal Reserve Banks across the country, as well as private member banks). In an economic sense, the discount rate is used to control overall interest rates (they get passed onto you as a consumer) and inflation (also passed onto you as a consumer). When you hear on the news about the Fed tinkering with interest rates as the economy is doing well/poorly, they’re talking about the discount rate.
Why would these member banks be borrowing from the Federal Reserve in the first place? They do all the time, actually, since they need to always meet their reserve requirements: legal requirements for how much money a bank needs to have on hand. Banks have a zillion things going on with money going all directions at once, with lots of investing where they can, so it’s not uncommon for the balance to be...off. Banks will often borrow from each other, but the Fed is always there if they need to borrow from it.
By making it more or less expensive to borrow money, the discount rate set by the Fed has ripple effects into the consumer market, the business market, and inflation (which oftentimes counterbalances unemployment). The discount rate is one domino that ends up affecting a lot of other dominos, including yours.
Related or Semi-related Video
Finance: What is the Dividend Discount M...2 Views
Finance allah shmoop what is the dividend discount model Well
it's a technique used to value companies or at least
it wass in the stone age And yet in the
nineteen fifties maybe which basically says that a company's value
is fully contained in the cash dividends it distributes back
to invest doors This model is only useful really for
its historical relevance We we just don't use that much
these days Yeah back in the old timey cave man
days when there was essentially no research of real merit
being done on the performance of investments of whatever flavor
the dividend discount model was the best thing investors had
to value an investment in a company And remember in
those days companies paid rial dividends that were a meaningful
percentage of the total value of the company Unless so
a company pays a dollar a share this year in
dividends Historically it's raised dividends at about three percent a
year like paid a dollar last you'd expect two dollars
three next year in dollars six and change the next
so well The dividend discount model discounts backto present value
And yes we have an opus on what president value
Means but here's the logline definition present value of all
future cash flows discounted for risk in time Back to
cars Yeah that thing well a few odd things are
worth noting in this horse and buggy era formula The
dividend discount model ignores the terminal or end value of
the company Like say twenty years from now the company
is sold for cash The dividends are all that are
really focused on though in our model that seem strange
to you Well maybe But let's say the discount rate
is ten percent in the risk free rate is four
percent for a total of fourteen percent a year discounted
back to the present So doing the math just looking
at the terminal value of say a hundred million bucks
in a sale to be made twenty years from now
Let's figure out what that's worth today Well you take
the one point one four Put it to the twentieth
power to reflect twenty years of discounted valuation compounding And
you say one point one four forty twenty powers about
thirteen point seven So to get the present value of
one hundred million bucks twenty years from now using this
discount rate Will you divide the hundred million by thirteen
point seven and that means that the one hundred million
dollars twenty years from now today is worth only seven
point three million bucks And yeah that's ah big haircut
kind of like this guy Well the formula focuses ah
lot on near term dividend distribution and it's Really more
interesting is a relic of original financial research in theory
than anything directly useful today And if you find this
interesting while then we may have a gig for you
here at shmoop finance central Yeah come on down We 00:02:39.715 --> [endTime] need writers good ones not like me
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