Federal Funds, a Short Term Loan
5. Federal Funds Federal Funds represent the asset to lending bank and liability to borrowing bank. The loan in Federal funds is short-term loan. Usually, the loans are for one to seven days. These funds help the bank to correct short-tem fund imbalances. Federal funds rate is interest rate charged in the federal funds. It is same for all banks borrowing in federal funds market. Federal funds market more active on Wednesday because that is final day of each particular settlement period for which each bank must maintain a specified volume of reserves required by Fed. 6. Federal Funds Market
Banks have to meet reserve requirements. Each Wednesday is the final day of each particular settlement period for which each bank must maintain a specified volume of reserves required by the Fed. When the bank does not meet the requirement, they have to borrow before settlement period ends. They can borrow in federal funds market. 7. Borrowing from Federal Reserve Rate is charged is primary credit lending rate. It is set at a level above the federal funds rate at any point in time, so bank will only borrow from Federal Reserve as last resort 10. Use of Funds Banks invest in securities because of the liquidity of securities.
They can convert securities immediately Moreover, Investing in securities is easier. Managing in Financial Markets Summary and analyze 1. The bank has traditionally focused on CDs 2. It offers checking accounts & money market deposit accounts (MMDAs) but it has not advertised these account: The bank does not have much short-term deposit. They cannot use short-term deposit to meet reserve requirement. 3. It pays about 3% points more on its CDs than on its MMDAs: obtaining CDs costs more than MMDAs, but the bank knows when the deposited fund is withdraw. Use of loans: Bank loans to build shopping malls and apartment complexes.
The demand for real estate is low, so the probability of defaulted loan increases. a. Bank should continue to focus on attracting funds by offering CDs, it also push the other types of deposits such as MMDAs. The Bank should make push the MMDAs, because it is cheaper source of fund. Besides MMDAs, and CDs, bank can obtain fund from another source. The main fund sources of banks are deposit account (Transaction deposits, Saving deposit, time deposits, MMDAc), borrowed funds (Federal funds purchased, borrowing from the federal reserve banks, Repurchase agreements, Eurodollar borrowing) Long-term sources of funds (Bonds, bank capital) . Bank should not focus on real estate loans because it put bank in the riskier position. The real estate market is going down, so the probability of defaulted real estate loan will increase. The bank should diversify their using of fund to reduce the risk. The bank can make loan to small business or different industry firms to diversify its borrowers. The common uses of funds by banks can be: * Reserving as Cash, bank holds cash to meet the reserve requirement. * Loaning, the loan is tailored to the borrower’s need. Investing in securities, which enable cash out the securities whenever they want. * Selling Federal funds, The bank can lend their extra fund to other banks in federal fund market * Setting up repurchase agreements, the bank can lend their money by purchasing a corporation’s holding of treasury securities with agreement selling back at a later date. * Making Eurodollar loans, the bank can loan their dollar in foreign market for corporations who need U. S dollar for their transaction. * Investing in Fixed Asset, Bank has to maintain some amount of fixed assets as requirement. . The potential return on the bank’s use of funds will increase under my restructuring of asset portfolio if the small business and the different industry firms can do well and the increase in value of securities such as mortgage backed securities The cost of funds will be increase under restructuring. First, to generate more funds, the administrative and advertising expense will increase. Second, The cost of each source is different. If the bank obtains more MMDAs, it can reduce the cost of fund. However if it generate money by issuing bond, the cost of fund will be greater.