Featured Pathways

More pathways

Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

More pathways

Book a demo

Pricing

Ready to get started?

Plans & Membership

Our Platform

Expert led content

+1,000 expert presented, on-demand video modules

Learning analytics

Keep track of learning progress with our comprehensive data

Interactive learning

Engage with our video hotspots and knowledge check-ins

Testing & certification

Gain CPD / CPE credits and professional certification

Managed learning

Build, scale and manage your organisation’s learning

Integrations

Connect Finance Unlocked to your current platform

Featured Content

More featured content

Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

More featured content

Book a demo

Pricing

Ready to get started?

Featured Pathways

More pathways

Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

More pathways

Book a demo

Pricing

Ready to get started?

Plans & Membership

Our Platform

Expert led content

+1,000 expert presented, on-demand video modules

Learning analytics

Keep track of learning progress with our comprehensive data

Interactive learning

Engage with our video hotspots and knowledge check-ins

Testing & certification

Gain CPD / CPE credits and professional certification

Managed learning

Build, scale and manage your organisation’s learning

Integrations

Connect Finance Unlocked to your current platform

Featured Content

More featured content

Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

More featured content

Book a demo

Pricing

Ready to get started?

Book a demo

Pricing

Ready to get started?

Effective Interest Rates and Discount Factors

Effective Interest Rates and Discount Factors

Moorad Choudhry

34 years: Banking and Capital Markets

In this second part of Moorad's introduction to the time value of money, he explains effective interest rates, present value and discount factors.

In this second part of Moorad's introduction to the time value of money, he explains effective interest rates, present value and discount factors.

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Effective Interest Rates and Discount Factors

9 mins 58 secs

Key learning objectives:

  • Understand the need and use of effective interest rates

  • Use discount factors to calculate the present value

Overview:

This further explanation of the time value of money includes calculations of effective rates, present value and the use of discount factors.

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Summary

What are effective interest rates?

The interest rate quoted on a deposit or loan is often the flat rate. However, we are often required to compare two interest rates which apply for a similar investment period but have different interest payment frequencies, for example, a two-year interest rate with interest paid quarterly compared to a two-year rate with semi-annual interest payments. This is normally done by comparing equivalent annualised rates. The annualised rate is the interest rate with annual compounding that results in the same return at the end of the period as the rate we are comparing.

The equivalent annual interest rate is known as the effective interest rate. We have already referred to the quoted interest rate as the “nominal” interest rate:

r = [ (1+aer)^(1/n) -1 ] * n

What are the interest rate conventions?

The convention in both wholesale or personal (retail) markets is to quote an annual interest rate. A lender who wishes to earn the interest at the rate quoted has to place her funds on deposit for one year. Annual rates are quoted irrespective of the maturity of a deposit, from overnight to ten years or longer.

The convention of quoting annualised rates is to allow deposits and loans of different maturities and different instruments to be compared on the basis of the interest rate applicable. We must also be careful when comparing interest rates for products that have different payment frequencies, as the actual interest earned will be greater for a deposit earning 6% on a semi-annual basis, compared to 6% on an annual basis. The convention in the money markets is to quote the equivalent interest rate applicable when taking into account an instrument’s payment frequency.

How do we calculate the Present value?

We can rearrange the future value equation, to give us the mathematical definition of present value, which we show here:

PV = FV/(1+r)^n  * 10

What are Discount factors, and when are they useful?

Discount factors are a very important component of financial markets analysis. The calculation of present values from future values is also known as discounting. It is the principles of present and future values that demonstrate the concept of the time value of money, which is that in an environment of positive interest rates, a sum of money has greater value today than it does at some point in the future because we are able to invest the sum today and earn interest. We will only consider a sum in the future compared to a sum today if we are compensated by being paid interest at a sufficient rate. Discounting future values allows us to compare the value of a future sum with a present sum.

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Moorad Choudhry

Moorad Choudhry

Professor Moorad Choudhry is a non-executive director at two UK financial institutions, having worked in London since 1989. He has experience in wholesale capital markets, treasury, ALM, and balance sheet management. Moorad's most recent role was as divisional treasurer at the Royal Bank of Scotland. He has also worked with Europe Arab Bank, KBC Financial Products, and JP Morgan. He is the author of "The Principles of Banking," which is currently in its 2nd edition.

There are no available Videos from "Moorad Choudhry"