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Federal Funds

What are 'Federal Funds'

Federal funds, often referred to as fed funds, are excess reserves that commercial banks and other financial institutions deposit at regional Federal Reserve banks; these funds can be lent, then, to other market participants with insufficient cash on hand to meet their lending and reserve needs. The loans are unsecured and are made at a relatively low interest rate, called the federal funds rate or overnight rate, as that is the period for which most such loans are made. Next Up Federal Discount Rate Federal Reserve Credit Reserve Requirements Eurodollar

Explaining 'Federal Funds'

Fed funds help commercial banks meet their daily reserve requirements, which is the amount of money that banks are required to maintain at their regional Federal Reserve. Reserve requirements are based on the volume of customer deposits that each bank holds.

Overnight Markets

The fed funds market operates in the United States and runs parallel to the offshore eurodollar deposit market. Eurodollars are also traded overnight and the interest rate is virtually identical to the fed funds rate, but the transactions must be booked outside of the United States. Multinational banks often use branches domiciled in the Caribbean or Panama for these accounts, even though the transactions may be executed in U.S. trading rooms. Both are wholesale markets with transactions ranging from $2 million to well over $1 billion.

Interest Rates

The Federal Reserve uses open market operations to manage the supply of money in the economy and adjust short-term interest rates. This means that the Fed buys or sells some of the government bonds and bills it has issued; this increases or decreases the money supply and, thus, lowers or raises short-term interest rates. Open Market Operations are carried out by the Federal Reserve Bank of New York.

Market Participants

The participants in the fed funds market include U.S. commercial banks, U.S. branches of foreign banks, savings and loan organizations, and government-sponsored enterprises, such as the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Association (Freddie Mac), as well as securities firms and agencies of the federal government.


Further Reading


The microstructure of the federal funds market
onlinelibrary.wiley.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Interest rate pass through and asymmetric adjustment: evidence from the federal funds rate operating target periodInterest rate pass through and asymmetric adjustment: evidence from the federal funds rate operating target period
www.tandfonline.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Predicting monetary policy with federal funds futures pricesPredicting monetary policy with federal funds futures prices
onlinelibrary.wiley.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Systemic illiquidity in the federal funds marketSystemic illiquidity in the federal funds market
pubs.aeaweb.org [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Announcement effects of the federal funds rate changes on exchange traded funds and bond yieldsAnnouncement effects of the federal funds rate changes on exchange traded funds and bond yields
pennstate.pure.elsevier.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

The response of the conventional mortgage rate to the Federal Funds rate: Symmetric or asymmetric adjustment?The response of the conventional mortgage rate to the Federal Funds rate: Symmetric or asymmetric adjustment?
www.tandfonline.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Interbank payments and the daily federal funds rateInterbank payments and the daily federal funds rate
www.sciencedirect.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Banks as monitors of other banks: Evidence from the overnight federal funds marketBanks as monitors of other banks: Evidence from the overnight federal funds market
www.jstor.org [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

Asymmetric effects of federal funds target rate changes on S&P100 stock returns, volatilities and correlationsAsymmetric effects of federal funds target rate changes on S&P100 stock returns, volatilities and correlations
www.sciencedirect.com [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …

A model of the federal funds rate targetA model of the federal funds rate target
www.journals.uchicago.edu [PDF]
… I. INTRODUCTION The federal funds market, the market where financial institutions buy and sell central bank reserves on a daily basis, is arguably among the most important financial markets. However, academic research on …



Q&A About Federal Funds


What is the Federal Funds Rate?

The Federal Funds Rate is the interest rate at which banks lend reserve balances to each other.

Where does the fed funds market operate?

The fed funds market operates in the United States and runs parallel to the offshore eurodollar deposit market.

How do open market operations work?

Open Market Operations are carried out by FRBNY through its trading desk at its headquarters at 33 Liberty Street in New York City's Financial District; they involve purchases or sales of securities from/to dealers on behalf of customers who have placed orders with it; these transactions affect both short-term interest rates (such as those on Treasury bills) and longer term interest rates (such as those on 10-year Treasury notes); FRBNY also conducts transactions directly with primary dealers who trade with it regularly; these transactions affect only short-term interest rates."

Who borrows and lends reserve balances in the federal funds market?

Banks are both borrowers and lenders of reserve balances in this market.

Why do transactions in the federal funds market not affect total reserves in the banking system as a whole?

Because when one bank lends another, it doesn't increase or decrease its own holdings of total reserves; instead, it transfers them.

How does a federal funds transaction redistribute reserves?

A federal funds transaction redistributes reserves from a bank with excess reserves to one that has insufficient reserves.

Who are some of the participants in this market?

U.S. commercial banks, U.S. branches of foreign banks, savings and loan organizations, and government-sponsored enterprises such as Fannie Mae and Freddie Mac participate in this market.

What determines how much money banks will borrow or lend on any given day?

Banks will borrow or lend until they have reached their desired level of required reserves. This occurs because borrowing costs are lower than lending costs, so banks prefer to borrow rather than lend if they can get away with it (i.e., if no one else needs to borrow). If there is an excess demand for loans by other banks, then borrowing rates rise above lending rates and more banks attempt to make loans until equilibrium between supply and demand is achieved. In general, excess demand for loans leads to higher interest rates while excess supply leads to lower interest rates.

What is the federal funds rate?

The federal funds rate is a very low interest rate that banks charge each other for overnight loans.

What do open market operations accomplish?

Open Market Operations manage money supply and adjust short-term interest rates by buying or selling government bonds and bills issued by the Federal Reserve Bank of New York (FRBNY).

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