Interest rates, put simply, are the cost of money. Overall interest rates are determined by the supply and demand for money, along with any upward price movement in the cost of goods and services, known as inflation. There are several key interest rates upon which all other rates depend.
These interest rates are:
- Discount rate
- Federal funds rate
- Broker call loan rate
- Prime rate
The Discount Rate
The discount rate is the interest rate that the Federal Reserve Bank charges on loans to member banks. A bank may borrow money directly from the Federal Reserve by going to the “Discount Window” and the bank will be charged the discount rate. The bank is then free to lend out this money at a higher rate and earn a profit, or may use these funds to meet a reserve requirement shortfall. Although a bank “may” borrow money directly from the Federal Reserve, it is discouraged and the discount rate has become largely symbolic.
Federal Funds Rate
The Federal Funds rate is the rate that member banks charge each other for overnight loans. The Federal Funds Rate is widely watched as an indicator for the direction of short-term interest rates.
Broker Call Loan Rate
The broker call loan rate is the interest rate that banks charge on loans to broker dealers to finance their customer’s margin purchases. Many broker dealers will extend credit to their customers to purchase securities on margin. The broker dealers will obtain the money to lend to their customers from the bank and the loan is callable or payable on demand by the broker dealer.
The Prime rate is the rate that banks charge their largest and most credit worthy corporate customers on loans. Prime rate has lost a lot of its significance in recent years as mortgage lenders base their rates on other rates, like the 10-year Treasury note. Prime rate is, however, very important for consumer spending as most credit card interest rates are based on prime plus a margin.
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