Economics Time Value Of Money Questions
The concept of discount factor frequency refers to the number of compounding periods within a given time period. It is used to calculate the present value of future cash flows by discounting them back to their present value.
The calculation of discount factor frequency depends on the compounding frequency, which can be annual, semi-annual, quarterly, monthly, or any other frequency. The formula to calculate the discount factor is:
Discount Factor = 1 / (1 + r/n)^(n*t)
Where:
- r is the interest rate per compounding period
- n is the number of compounding periods per year
- t is the number of years
For example, if the interest rate is 5% per year and the compounding is semi-annual (n = 2), the discount factor would be calculated as:
Discount Factor = 1 / (1 + 0.05/2)^(2*t)
The discount factor frequency is important because it determines the rate at which future cash flows are discounted. A higher compounding frequency leads to a lower discount factor, resulting in a higher present value of future cash flows.