A technique which is used to convert an interest rate of a given period into an interest rate of a shorter period. For example, an investor may need to imply a monthly rate from a quarterly rate or semiannual rate.
The decompounding formula is:
Rate = [(1+i)1/n – 1] x n
where: i is the interest rate being decompounded, n is the number of periods the original rate is being decompounded into. Suppose an investor is attempting to convert a semiannual rate of 7% to a monthly rate. In this case, the number of periods (months in our example) is six. Therefore, the decompounded rate is: monthly rate = [(1+6%)1/6 – 1] x 6 = 5.86%
In this sense, the difference between the semiannual rate and the monthly rate is 0.14% or 14 basis points.
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