Glossary
Discount Rate
The rate used to convert future cash flows to present value; also the rate the Fed charges banks at its discount window.
On this page
"Discount rate" has two common meanings in finance. In valuation, it is the annual rate used to translate money expected in the future into its value today. In central banking, it is the interest rate the Federal Reserve charges banks that borrow directly from it at the discount window. The two are related only by name.
In valuation
A dollar received in five years is worth less than a dollar today, because today's dollar could be invested in the meantime and because the future one might not arrive. The discount rate captures both: a Risk-free rate plus a Risk premium for uncertainty.
Companies often use their weighted average cost of capital (WACC) as the discount rate in a Discounted Cash Flow (DCF) model. Small changes in the rate move the result a lot, especially for growth companies whose cash flows lie far in the future, which is one reason their stocks tend to fall hard when interest rates rise.
At the Federal Reserve
The Fed lends to eligible banks through its discount window, mainly via "primary credit" for sound institutions. Since 2020, the primary credit rate has been set at the top of the Federal Open Market Committee's target range for the Federal funds rate. Discount-window borrowing is a backstop: banks normally borrow from one another first, and heavy use of the window tends to show up only in periods of stress, such as the March 2023 bank failures.