Annual effective discount rate

The annual effective discount rate expresses the amount of interest paid or earned as a percentage of the balance at the start of the annual period. This is in contrast to the effective rate of interest, which expresses the amount of interest as a percentage of the balance at the end of the period. The discount rate is commonly used for U.S. Treasury bills and similar financial instruments.

For example, consider a government bond that sells for $95 and pays $100 in a year's time. The discount rate is

${\displaystyle {\frac {100-95}{100}}=5.00\%}$

The interest rate is calculated using 95 as the base

${\displaystyle {\frac {100-95}{95}}=5.26\%}$

which says that ${\displaystyle 95\%}$ of $105.26 is $100.

For every effective interest rate, there is a corresponding effective discount rate, given by

${\displaystyle d={\frac {i}{1+i}}}$

or inversely,

${\displaystyle i={\frac {d}{1-d}}}$

Given the above equation relating ${\displaystyle \,d}$ to ${\displaystyle \,i}$ it follows that

${\displaystyle d={\frac {1+i-1}{1+i}}={\frac {1+i}{1+i}}-{\frac {1}{1+i}}\ =1-v}$ where ${\displaystyle v}$ is the discount factor

or equivalently,

${\displaystyle v=1-d}$

Since ${\displaystyle \,d=iv}$, we have

${\displaystyle id=i-d}$