Bank Analysis School - Case Study & Resources

APPENDIX A - DEFINITION AND TYPES OF INTEREST RATE RISK APPENDIX B: Common Interest Rate Indices

Federal Funds Rate

• Short-term interest rate at which banks lend reserve balances to each other overnight • Set by the Federal Open Market Committee (FOMC) of the Federal Reserve, which adjusts the target range as part of monetary policy to control inflation, stabilize employment, and maintain economic growth • Changes in this rate influence other interest rates • Deposit costs (like rates paid on savings accounts and CDs) tend to move in the same direction as the Federal Funds Rate but often with a lag and not in full proportion. Deposit repricing behavior can vary significantly between banks based on customer base, growth strategy, and competitive environment. Prime Rate • Interest rate banks charge their most creditworthy (prime) commercial borrowers. • Often used as a reference for variable-rate consumer and commercial loans (such as credit cards, auto loans, home equity lines of credit (HELOCs), and some commercial loans) • The Wall Street Journal Prime Rate is typically set at 3% above the Federal Funds rate. Some community banks use the WSJ Prime Rate as a reference, while others set their own prime rate (bank-specific prime rates are usually close to the WSJ rate but may vary slightly based on the bank's pricing strategy) Secured Overnight Funding Rate (SOFR) • A broad measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities • Administered by The Federal Reserve Bank of New York. • Commonly used as a benchmark for floating-rate loans and derivatives (e.g., interest rate swaps) U.S. Treasury Rates / Constant Maturity Treasury Rates • Constant maturity treasury rates reflect the yields on U.S. Treasury securities with standard maturities (e.g., 1-year, 5-year, 10-year), published daily by the U.S. Treasury to track risk-free interest rates • The 10-year Treasury rate is commonly used as a benchmark to price real estate loans, especially residential mortgages but also commercial real estate and farmland loans) • Securities yields are based on the shape of the U.S. yield curve at the time the bonds are purchased, along with any additional risk premium