RESERVE MONEY

E. (2b) Rediscounting
The central Bank can raise the levels of reserves and credit money by widening its
rediscounting windows and buying more loan papers at lower and more encouraging
rediscount rate.
Conversely, it decreases reserves and money supply by raising the rediscount rate
and narrowing its rediscounting windows to buy more loan papers. This is illustrated
using the equations of the preceding section as follows:

Money created

Money created

Illustration:
Let us assume that a bank lends P100,000 at an annual interest rate of 30% and,
therefore, expects to get back a compounded value of P169,000 after two years.
However, let us assume further that at the end of the first year, the bank sells the loan
paper to the Central Bank to get back the principal and possibly earn interest for the one-
year period completed before maturity. The Central Bnak offers a purchase or present
value of the paper to the purchase period using a rate called the rediscount rate. The
following equation illustrates:

where:
P = Present Value
F = future Value
r = Discount Rate
f = number of years back from maturity to purchase

Given:
F = 169,000
r = 30%
f = 1 year

Solution:
P= 169,000
(1 + .3)
P = 130,000

Explanation:
 In the example just given, the Central Bank discounts the future value of the loan
paper equal to P169,000 to a period one year before maturity which is also one year after
lending. Using a rediscounting rate of 30% per year, which is equal to the interest rate of
the loan, yields a purchase or present value of P130,000.
Or simply this purchase value is also equal to the loan principal of P100,000 plus
the interest earned by the bank equal to P30,000 for lending this principal at a rate of 30%
per year for one year.
Present Value = Principal + Interest earned for years of lending before selling the
loan paper.
P = 100,000 + (