Discounting 1 Allowing For

Discounting 1 Allowing For

Discounting. (1)Allowing for expected changes in security prices, commodity prices, rates of exchange, etc. For example, when a fall in the value of a security is anticipated for some reason, large numbers of holders may decide to sell before the fall takes place; such large sales may depress the value of the security in advance, so that when the expected event occurs part of its effect has already been 'discounted' by the market. Changes in the values of securities may be expected because an expected change in Bank rate would affect the price of fixed-interest securities, and speculators would buy or sell depending on whether they expected a fall or a rise in Bank rate. Expectation of the dividends on the shares of quoted public companies will affect their price. Anticipated scarcities in commodities may induce purchasers to buy larger stocks than they otherwise would, so increasing the price in advance. An anticipated change in an exchange rate between currencies may stimulate purchases and sales of them, bringing the market rates nearer to the expected rates.

Such discounting of news is common in money markets, foreign exchange markets, commodity markets and security markets; one of the incidental advantages is that it tends to reduce the severity of day-to-day fluctuations in market prices and to bring about more gradual adjustments than would otherwise occur.

(2) The process of calculating the present value of a sum to be received at a future date or of a stream of future payments. The present value depends on the rate of discount or interest applied. If funds can be invested in similar rights to yield, say, 6 per cent, the present value of the right to i receivable in 5 years' time will be £4000.; of Lx receivable in 4 years, £18, 200.; of Lx receivable in 3 years, £13, 750.; and so on. The sum of this series, i.e. the present value of Li per annum for 5 years, will be £3, 250.

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