Federal Funds Rate
The most well know function of the Fed, the Federal Funds Rate is just one tool the Federal Reserve uses to influence the nations economy, but the most watched by the average investor and the public in general.
The Federal Open Market Committee meets eight times a year to discuss the federal funds rate. The federal funds rate is the rate charged by banks to other banks needing overnight loans to meet reserve requirements. This interest rate only effects short term.
Most traders and investors mistakenly think the Federal Reserve sets the Federal Funds Rate. This is not true, the rate stated is what is known as the target rate. The actual rate fluctuates according to supply and demand and is not under the direct control of the Fed. However, it is STRONGLY influenced by the Fed's actions.
The interest rate has a unique purpose. It is mandatory that banks keep a certain level of cash reserves on hand. The amount the banks need to maintain depends on their level of deposits. Throughout the day some bank reserves may drop below the required level. When this occurs, those banks have to borrow funds from other banks until they reach their required reserve level. The interest rate charged to the bank for borrowing funds is the federal funds rate.