ATTEMPT TO UNDERSTAND THIS

Anything Bob Chapman writes, that you don't understand, PLEASE Google the terms. This is one that is critical for you to understand. Log on to this URL and read EVERYTHING and EVERY LINK in it. GT... http://en.wikipedia.org/wiki/Federal_funds_rate Federal funds rate From Wikipedia, the free encyclopedia In the United States, the federal funds rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1] Changing the target rate is one form of open market operations that the Chairman of the Federal Reserve uses to regulate the supply of money in the U.S. economy.[2] Contents [hide] * 1 Mechanism * 2 Applications * 3 Comparison with LIBOR * 4 Predictions by the market * 5 Historical rates * 6 Impact of federal funds rate cuts * 7 See also * 8 References * 9 External links [edit] Mechanism U.S. banks and thrift institutions are obligated by law to maintain certain levels of reserves, either as non-interest-bearing reserves with the Fed or as vault cash. The level of these reserves is determined by the outstanding assets and liabilities of each depository institution, as well as by the Fed itself, but is typically 10%[1] of the total value of the bank's demand accounts (depending on bank size). For example, assume a particular U.S. depository institution, in the normal course of business, issues a loan. This dispenses money and reduces the bank's reserves. If its reserve level falls below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate. The nominal rate is a target set by the governors of the Federal Reserve, which they enforce primarily by open market operations. That nominal rate is almost always meant by the media referring to the Federal Reserve "changing interest rates". The actual Fed funds rate generally lies within a range of that target rate, as the Federal Reserve cannot set an exact value through open market operations. Another way banks can borrow funds to keep up their required reserves is by taking a loan from the Federal Reserve itself at the discount window. These loans are subject to audit by the Fed, and the discount rate is usually higher than the federal funds rate. Confusion between these two kinds of loans often leads to confusion between the federal funds rate and the discount rate. Another difference is that while the Fed cannot set an exact federal funds rate, it can set a specific discount rate. The federal funds rate target is decided by the governors at Federal Open Market Committee (FOMC) meetings. The FOMC members will either increase, decrease, or leave the rate unchanged depending on the meeting's agenda and the economic conditions of the U.S. It is possible to infer the market expectations of the FOMC decisions at future meetings from the Chicago Board of Trade (CBOT) Fed Funds futures contracts, and these probabilities are widely reported in the financial media. [edit] Applications Interbank borrowing is essentially a way for banks to quickly raise capital. For example, a bank may want to finance a major industrial effort but not have the time to wait for deposits or interest (on loan payments) to come in. In such cases the bank will quickly raise this amount from other banks at an interest rate equal to or higher than the Federal funds rate. Raising the Federal funds rate will dissuade banks from taking out such inter-bank loans, which in turn will make cash that much harder to procure. Conversely, dropping the interest rates will encourage banks to borrow money and therefore invest more freely.[3] Thus this interest rate acts as a regulatory tool to control how freely the US economy, and by consequence - as there exists a certain interdependence - world economy, operates. By setting a higher discount rate the Federal Bank discourages banks from requisitioning funds from the Federal Bank, yet positions itself as a source of last resort. [edit] Comparison with LIBOR Though the London Interbank Offered Rate (LIBOR) and the federal funds rate are concerned with the same action, i.e. interbank loans, they are distinct from one another, as following: * The federal funds rate is a target interest rate that is fixed by the FOMC for implementing U.S. monetary policies. * The federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies' securities).[4] * LIBOR is calculated from prevailing interest rates between highly credit-worthy institutions. * LIBOR may or may not be used to derive business terms. It is not fixed beforehand and is not meant to have macroeconomic ramifications.[5] GT sez: There is lots more, so go to the URL and read it all. It's not that hard to understand.