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 6% 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%
Therefore, the difference between the semiannual rate and the monthly rate is 0.14% or 14 basis points.
Hello,
I note your example contains an typo. Should it be (1+7%)?
Hi, Mark. What you said is true. The typo has been corrected. Many thanks.