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What is a Discount Rate?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 28 November 2016
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Discount rates can identify two different types of financial activity. One common use of the term has to do with the amount of interest that private banks pay to the United States Federal Reserve System in return for loan financing. The second application of the term has to do with the charge that merchants pay in order to process credit card payments as part of doing business.

When it comes to a Federal Reserve Discount Rate, the discount rate process lets the banks and other financial institutions to receive loans from the Federal Reserve at rates that are considered to be very competitive. This extension of a discount rate has an impact in two different ways. The immediate effect is that it makes it possible for financial institutions to pass on a portion of the savings to their clients.

However, the extension of a discount rate through the Federal Reserve can have a far reaching impact on investors and the function of various investment markets. Bond markets tend to react to the change in the discount rate, since available rates of interest have a direct impact on the desirability of bond purchases. While the stock market is less vulnerable to a change in the direct rate, it is still possible for a change in rate to impact the performance of the stocks of various companies who trade on the exchange.

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In terms of merchants, the discount rate has to do with the charge that is applied each time a merchant allows a customer to use a credit card to pay for goods or services received. In most cases, the charge is a fixed percentage of the transaction. Each major credit card issuer determines the exact percentage that is charged per transaction.

It is possible for merchants to receive a discount off the standard and usual percentage applied to each transaction. The discount rate is often extended based on the volume of business that the merchant generates with the credit card processor in question. This means that major retail businesses or other businesses that make extensive use of credit card purchasing options have the opportunity to receive payments quickly and with less expense involved.

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