Impact of U.S. Federal Reserve's Discount Rate and Federal Funds Rate on Financial Institutions and Markets

Financial Institutions and Markets
U.S. Federal Reserve
STUDENT NAME

Financial Institutions and Markets
The federal bank discount rate is how much Central Bank of US charges its other banks
to borrow from its give discount window to maintain the reserve it requires. In addition to this,
federal fund rate is the interest rate at which financial and depository institutions lend reserve
balances to other depository on the basis of collateralized securities. After reviewing the Federal
Reserve website and other required details, it is analysed that there will be following impacts on
the financial institutions and market due to the change in the discount rate and federal funds rate
target made by the U.S. Federal Reserve (Federal Reserve Discount Rate, (2018).
Stock market indices react to these changes
With the increase in the discount rate to 2.75% which is .25% higher and 2.25 Federal
Reserve rate, it has been observed that the market capitalization of the ordinary stock index has
decreased (Federal Reserve Discount Rate, 2018). Ideally, government increases this both rates
with a view to control the money supply in economy. It is analyzed that when the discount rate
and Federal Reserve rate are increased then investors and companies both tend to decrease their
investment and keep money liquid in their business. Therefore, the main impact of these changes
would be less market capitalization of the stock market indices (Federal Reserve, 2018).
Reaction of long-term U.S. Treasury bond yields react to these changes
The reaction of the long-term U.S. Treasury bond yields react to these changes is that
investors are more inclined towards investing their capital in these bonds and the market
capitalization of the government yield securities has increased by 12% if it is compared with the
data of last 15 days. It is analyzed that due to the increment in these both rates, it has also
impacted the gilt securities and government bonds (Bricker, et al.2017). There is the inverse
relationship between the price of the gilt securities and these two interest rates. It is found that
when these interest rate rise, bond prices fall and vice-versa. All the government bonds and .S.
Treasury bond yields has fluctuated more in relation to these interest rates. It is analysed that
when the fed raises these rates then the newly offered government securities such as gilt
securities and treasury bills will have corresponding increase in the interest rates. The rate of risk
free return (RF) will increase (Hancock, & Passmore, 2015).
1