Prime rate

Definition

The prime rate is the interest rate that commercial banks charge their most creditworthy customers, typically large corporations. It serves as a benchmark for various other interest rates including those for loans and mortgages.

5 Must Know Facts For Your Next Test

1. The prime rate is influenced by the Federal Reserve's federal funds rate.
2. Changes in the prime rate can affect bond prices and yields.
3. Banks often use the prime rate as a base to set rates on variable-rate loans.
4. A higher prime rate generally indicates tighter monetary policy and can lead to higher borrowing costs.
5. The prime rate is typically about 3% higher than the federal funds rate.

Review Questions

• How does the prime rate impact bond prices?
• What external factor primarily influences changes in the prime rate?
• Why do banks use the prime rate as a base for setting other interest rates?

Related terms

Federal Funds Rate: The interest rate at which depository institutions lend reserve balances to other depository institutions overnight.

Yield Spread: The difference between yields on different debt instruments, often indicative of credit risk or economic outlook.

Variable-Rate Loan: A loan with an interest rate that fluctuates based on an underlying benchmark, such as the prime rate.