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Effective Rates of Interest and Discount

The effective rate of discount is used in computing the present values of certain types of annuities. Assuming as the rate of interest per annum, an investor who deposits Re 1 at the beginning of the year would receive Re (1 + i) at the end of the year. If he demands the interest payment in the beginning of the period, as money has time value, he would obviously get an amount less than i (assumed to be d). He would effectively lend Re (1 – d) at the beginning of the year and get back Re 1 after one year. The relationship between i and d is called the effective rate of discount per annum. Symbolically,

d = i/(1+i)

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