Fed Funds

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Fed Funds</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="98%" align="left" valign="top"><p class="word_list"> <a href="#effective fed funds rate">effective Fed funds rate</a><p class="word_list"> <a href="#Fed funds">Fed funds</a><p class="word_list"> <a href="#Fed funds market">Fed funds market</a><p class="word_list"> <a href="#Fed funds rate">Fed funds rate</a><p class="word_list"> <a href="#Fed Wire">Fed Wire</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table5"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p>The <b><a name="Fed Wire">Fed Wire</a></b> is an electronic funds transfer system linking </p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">the <a href="../articles/united_states_financial_regulation.htm">Federal Reserve</a> Board of Governors, </p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">the twelve regional Federal Reserve Banks and their branches, </p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">the US Treasury Department, and </p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">other federal agencies. </p> <p><a href="../articles/settlement.htm">Settlement</a> of transfers is same-day, which makes the system convenient for large fund transfers. US banks maintain deposits with their regional Federal Reserve banks, which allows them to use the system for settling a variety of interbank transactions, such as loans, <a href="../articles/certificate_of_deposit.htm">certificates of deposit</a>, or <a href="../articles/repo.htm">repos</a> . The deposits are called Federal funds (or <b><a name="Fed funds">Fed funds</a></b>). The main reason banks hold them is because the Fed requires them to maintain cash reserves as Fed funds. </p> <p>Deposits at the regional Federal Reserve banks earn no interest, so banks perform a balancing act every day, trying to offset transactions in and out of their accounts so they end each day with Fed funds that equal but do not exceed their reserve requirements for the day. </p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table6"> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p>On any given day, some banks find themselves short Fed funds while other banks find they have excess Fed funds. There are various ways banks can lend each other their Fed funds. Repos are a form of <a href="../articles/collateral.htm">secured lending</a>. There is also a large market for unsecured loans. This is called the <b> <a name="Fed funds market">Fed funds market</a></b>. Most of those loans are arranged by brokers. Transactions can be for <a href="../articles/coupon_bond.htm">terms</a> of as long as a year, but the vast majority are overnight loans. </p> <p class="body">One way the Fed conducts its monetary policy is to set a target interest rate for overnight Fed Funds. The actual rates banks pay are negotiated by those banks, but by expanding or contracting the money supply, the Fed can usually move those rates towards its target rate. When you hear people speak about the <b><a name="Fed funds rate">Fed funds rate</a></b>, they may be referring to the Fed's stated target rate. They may also be referring to the <b><a name="effective fed funds rate">effective fed funds rate</a></b>. This is a dollar-weighted average of interest rates payable on overnight Fed funds. It is compiled daily by the New York Federal Reserve Bank and is based on transactions arranged by major brokers.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table7"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table8"> <tr> <td width="100%"> <cop yrigh t( c)c ont i ngen cy anal y sis, 2 00 5> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/agency_securities.htm">agency security</a> A security issued by a US federal agency or government sponsored enterprise.</p> <p 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width="100%"> <p class="explanatory_text">Fabozzi, Mann and Choudhry (<a target="_blank" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm">2002</a>) has detailed information on Fed funds and other aspects of the money market.</p> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table10"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap502"> <area target="_blank" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm" shape="rect" coords="0, 0, 82, 124"> </map> <img border="0" src="../images/book_fabozzi_mann_choudhry_(2002)_125.gif" usemap="#FPMap502" width="83" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table11"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" 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