Series 7 practice questioneasyMoney Market — Federal Funds vs Discount Rate
Which statement BEST distinguishes the federal funds rate from the discount rate?
- AThe federal funds rate is set directly by the Fed, while the discount rate is market-determined
- BThe federal funds rate is for interbank overnight lending, while the discount rate is the rate the Federal Reserve charges banks for borrowing directly from the Fed's discount window✓ Correct answer
- CBoth rates are identical and always move together
- DThe discount rate only applies to consumer loans
Explanation
Why B — The federal funds rate is for interbank overnight lending, while the discount rate is the rate the Federal Reserve charges banks for borrowing directly from the Fed's discount window
The federal funds rate is the rate at which banks lend excess reserves to each other overnight, influenced by FOMC policy through open market operations. The discount rate is the rate the Federal Reserve directly charges commercial banks for short-term loans from its discount window. The discount rate is typically set above the federal funds rate target to encourage banks to borrow from each other before turning to the Fed as a lender of last resort.
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