Chapter 15.3, Problem 5R

To determine

To evaluate: The difference between discount rate and prime rate.

Explanation of Solution

There are two distinct definitions of discount rate and usages, depending on the context. Firstly, the discount rate refers to the interest rate paid to other financial institutions and commercial banks for the loans they receive from the Federal Reserve Bank through the lending mechanism of discount window, and secondly, the discount rate refers to the rate of interest used in the Discounted Cash Flow analysis to calculate the present value of potential cash flows.

The prime rate is the rate of interest paid by the commercial banks to their most worthy of credit corporate clients. The overnight federal funds rate acts as the base for the prime rate, and prime is the starting point for most other rate of interests.

Economics Concept Introduction

Introduction: A very short-term debt transactions is called a money market. This involves large-volume transactions at the wholesale level between companies and traders. This comprises mutual money market funds purchased by single investors at the retail stage, and money market accounts opened by bank customers.