Federal Funds Rate

B is correct. When the FOMC raises the federal funds rate, it puts upward pressure on all interest rates across the economy. As rates rise, newly issued bonds offer higher yields, making existing bonds with lower coupon rates less attractive. Bond prices fall to compensate (inverse relationship between rates and bond prices). This immediate price impact affects Maria's 60% bond allocation negatively in the short term.

A is incorrect because it reverses the fundamental inverse relationship between interest rates and bond prices. When rates rise, bond prices fall, not rise. C is incorrect because while the fed funds rate technically applies to overnight interbank lending, it serves as the benchmark that influences all other interest rates throughout the yield curve, affecting bonds of all maturities. D is incorrect because the fed funds rate is the primary monetary policy tool that affects the entire economy, including investment portfolios. Rising rates typically pressure both bond and stock prices.

B is correct. The FOMC meets eight times per year, approximately every six weeks, to review economic conditions and set the target range for the federal funds rate. These scheduled meetings are publicly announced in advance, and the policy decisions are closely watched by financial markets worldwide.

A (monthly/12 times) is too frequent. While the Fed monitors conditions continuously, formal FOMC policy meetings occur less often. C (quarterly/4 times) is too infrequent and confuses the FOMC meeting schedule with quarterly earnings seasons. D (semi-annually/2 times) is far too infrequent for effective monetary policy management in a dynamic economy.

B is correct. When the Fed raises rates (and may continue raising them), shifting from long-term to short-term bonds reduces interest rate risk. Short-term bonds have lower duration, meaning their prices are less sensitive to rate changes. Additionally, short-term bonds mature sooner, allowing reinvestment at the new higher rates. This is a defensive strategy appropriate during a rising rate environment.

A is incorrect and counterproductive. Extending duration (moving to longer-term bonds) increases interest rate risk precisely when rates are rising. Long-term bonds would experience larger price declines as rates continue to increase. C is incorrect because fixed-rate preferred stocks behave like long-term bonds and would decrease in value as rates rise, not benefit. Rising rates make the fixed dividend less attractive compared to new issues with higher yields. D is incorrect because while cash becomes more attractive in a rising rate environment (higher yields on money market funds), completely abandoning diversification is never appropriate financial advice. A balanced approach with reduced duration makes more sense.

C is correct (the EXCEPT answer). The federal funds rate is NOT set by Congress. It is set by the Federal Open Market Committee (FOMC), which is part of the Federal Reserve System (an independent central bank). This is a critical distinction that frequently appears on the Series 65 exam. Congress and the President control fiscal policy (taxes and spending), while the Fed independently controls monetary policy (money supply and interest rates).

A is accurate: the fed funds rate is indeed the rate for overnight interbank lending, primarily used by banks to meet reserve requirements. B is accurate: since 2008, the FOMC has announced a target range (e.g., 5.25% to 5.50%) rather than a single rate, allowing for a corridor approach to rate setting. D is accurate: the fed funds rate serves as the benchmark that influences all other interest rates in the economy. When the Fed raises the fed funds rate, banks typically increase rates on mortgages, auto loans, credit cards, and other consumer and business loans.

B is correct. Only statements 2 and 4 are accurate.

Statement 1 is FALSE: Raising the federal funds rate is contractionary monetary policy, not expansionary. The Fed is tightening monetary conditions to slow the economy and combat inflation, not stimulate growth. Expansionary policy would involve lowering rates.

Statement 2 is TRUE: When the fed funds rate increases, interest rates throughout the economy tend to rise. Since bond prices and interest rates have an inverse relationship, rising rates cause existing bond prices to fall. New bonds are issued at higher yields, making existing bonds with lower coupon rates less valuable.

Statement 3 is FALSE: The discount rate is typically HIGHER than the federal funds rate, not lower. The discount rate (what the Fed charges banks for direct borrowing from the Fed discount window) is usually set 0.50% to 1.00% above the fed funds rate to encourage banks to borrow from each other rather than from the Fed.

Statement 4 is TRUE: Raising rates is a contractionary policy tool designed to slow economic activity by making borrowing more expensive. This reduces consumer spending and business investment, which helps cool demand and reduce inflationary pressures. The FOMC explicitly cited "persistent inflation concerns" as the reason for the increase.