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Difficulty: EasyInterest Rate Dynamics and Yield Curve Analysis

Which benchmark interest rate is directly negotiated between commercial banks when lending excess reserve balances to one another on an overnight basis?

  1. Federal funds rateAnswer
  2. B
    Discount rate
  3. C
    Prime rate
  4. D
    Call money rate

Answer

The federal funds rate is the benchmark interest rate commercial banks charge each other for overnight loans of reserve balances held at the Federal Reserve.
The federal funds rate is the interest rate commercial banks charge one another for overnight loans of reserve balances stored at the Federal Reserve Bank. It is determined by supply and demand in the market for interbank funds.

Step-by-Step Solution

1
Identify the key characteristics given in the scenario
The rate involves bank-to-bank overnight lending of excess reserves.
The question specifically describes interbank transactions involving reserve balances.
2
Evaluate the definition of the federal funds rate
The federal funds rate matches the market-driven interbank overnight lending mechanism exactly.
It represents the rate at which depository institutions trade excess reserves with each other overnight.

Key Concept

Federal Funds Rate vs. Other Benchmark Interest Rates
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Topics

Interest Rate Dynamics and Yield Curve Analysis

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