Discount Rate

A is correct. When the Federal Reserve raises the discount rate, it signals a tightening of monetary policy, which typically leads to higher interest rates throughout the economy. As interest rates rise, existing bonds with lower coupon rates become less attractive, causing their prices to fall. This inverse relationship between interest rates and bond prices is fundamental to fixed-income investing. B is incorrect because the discount rate change does affect broader markets through its signaling effect and impact on overall interest rates. C is incorrect because rising rates generally cause bond prices to fall, not rise. D contains a factual error (the question states an increase, not a decrease) and misrepresents the relationship.

C is correct. The discount rate is the interest rate the Federal Reserve charges commercial banks and depository institutions for short-term loans borrowed directly from the Fed's discount window. A describes the prime rate, not the discount rate. B describes the mechanism of open market operations but doesn't define the discount rate (the Fed doesn't use a single "rate" for OMOs; rather, it buys/sells securities to influence the money supply). D describes the federal funds rate, which is the market-determined rate for interbank lending.

C is correct. There is a well-documented "discount window stigma" where banks avoid borrowing from the Fed because it may signal to regulators, other banks, and the market that the institution is experiencing financial difficulties. Banks often prefer to pay higher rates in the federal funds market to avoid this perception. A is incorrect because discount window loans do require collateral, but most banks have eligible securities available. B is incorrect because healthy banks can access primary credit at the discount window. D is incorrect because discount window loans are typically short-term (often overnight), not longer-term commitments.

D is correct (this is the exception/false statement). The discount rate is NOT the primary tool for day-to-day monetary policy implementation. Open market operations (buying and selling Treasury securities) are the Fed's primary tool for implementing monetary policy on a day-to-day basis. The discount rate serves more as a backup lending facility and signaling mechanism. A is true: the Board of Governors sets the discount rate. B is true: the discount rate is typically 0.5-1.0% above the federal funds rate to discourage overuse. C is true: raising the discount rate signals tighter monetary policy and is contractionary.

B is correct (I, III, and IV only). I is true: lowering the discount rate signals the Fed is easing monetary policy to stimulate the economy. III is true: a lower discount rate is intended to make borrowing cheaper, encouraging banks to lend more and increasing overall liquidity and economic activity. IV is true: a lower discount rate reduces the cost of borrowing from the Fed, making the discount window relatively more attractive (though stigma may still discourage use). II is false: the federal funds rate does not automatically decrease by the same amount. While the discount rate influences the federal funds rate, the fed funds rate is market-determined through interbank lending, not directly controlled by the Fed. The Fed targets the fed funds rate through open market operations, not by changing the discount rate.