Question

The Federal Reserve pays interest on the reserve deposits banks hold with the Fed. Explain if and how the banks could earn any profit without cost in the following situations by taking advantage of differences in the Discount rate, Federal funds rate and interest paid on reserves. Banks would just borrow/lend each other or from the Fed or hold reserves in their account.

-The discount rate is 2.5%, the effective federal funds rate is 2% and the interest paid on reserve deposit is1.5%

Answer 1

Ans:-

Discount rate = min interest FED charges other banks to lend money (cost to bank)

Effective federal funds = Banks charges other banks to lend for overnight (Income to bank)

Interest paid on reserve deposits = Interest paid by FED to Banks for keeping the reserve deposit (Income to bank)

So, Net income = Income - Cost

= 2%+1.5%-2.5%

= 1%