The Bank of Key West is not going to have enough reserves at the end of the busi
ID: 1197043 • Letter: T
Question
The Bank of Key West is not going to have enough reserves at the end of the business day to meet its reserve requirement of 10%. It currently has two options to borrow money overnight in order to meet the requirement. First, it could borrow money from the Federal Reserve at a rate of 1.35%. Second, it could borrow money from other banks at a rate of 0.45%. Using this information answer the following questions.
Required:
1. What is the federal funds rate
2. What is the discount rate
3. (multiple choice) What would happen to other short-term interest rates if the Fed increases its federal fund rate target?
a. They should remain unchanged
b. the would also increase
c. they would become irrelevant
d. they would decrease
Explanation / Answer
1. 0.45% Federal funds rate is the rate at which a bank borrows from other banks. In the question, 0.45% is federal funds rate. this rate is commonly applicable to the creditworthy institutions. The rate is suggested by FOMC and decided through demand supply. this is the rate that we see in newspapers and tv. The federal reserves uses open market operations to control the money supply and thereby to control the federal funds rate.
2. 1.35% Discount rate is the rate at which a bank can borrow from the Federal Reserves. In the question, it is 1.35%. the rate is set by federal reserve banks, rather than a market rate of interest. the discount rate will be usually higher than fed funds rate.
3. They would also increase (Reason- Fed funds rate has very high impact on the new economic activity and new lending activity. When fed funds rate increase, money supply in the market decreases. It becomes more expensive to borrow. This results in the short term interest rates to rise.)
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