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EDWARD J. /14cCARTHY
Federal Reserve Bank of Boston

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Federal Reserve Bank of St. Louis

First Printing, 1964 2M
Republished, May 1971 2M
Reprint, May 1972 2500
Reprint, July 1973 2500
Reprint, May 1975 2500
Reprint, May 1976 3M
Reprint, May 19773M
Reprint, May 1978 3M
Reprint, February 1979 4M
Reprint, February 1980 8M

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Federal Reserve Bank of St. Louis

PREFACE
The material presented in this thesis represents the personal views
and opinions of the writer. Nothing contained herein should be
construed as reflecting the views or policies of the Federal Reserve
Bank of Boston or the Board of Governors of the Federal Reserve
System.


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Federal Reserve Bank of St. Louis

Edward J. McCarthy

CONTENTS
Chapter

Page

I PURPOSE

9

II RESERVES
Description of Required Reserves
Computation of Reserve Position
Excess Reserves

13
13
15
18

III FEDERAL RESERVE FUNDS
Description of Federal Reserve Funds
Mechanics of Transactions in Federal Funds
Legal Limits

23
23
25
26

IV REPURCHASE AGREEMENTS OR "BUY BACKS"
Agreements with Dealers
Agreements with Bank Customers

29
29
30

V SECONDARY RESERVES
Description of Treasury Obligations
Purchase and Sale of Treasury Bills
Commercial Paper
Bankers' Acceptances
Negotiable Certificates of Deposit
The Prime Rate
VI RELATIONS WITH CORRESPONDENT BANKS
Loan Participations
Direct Borrowing
VII THE DISCOUNT WINDOW
Foreword to Regulation A
Borrowings Secured by U.S. Governments
Borrowings Secured by Eligible Paper
Rediscounts of Eligible Paper
Borrowings Under Section 10(b)
Proposed Revision of Discount Window
Administration

35
35
35
41
45
48
51
.

53
53
53
57
57
59
65
69
69
73

CON1MENTS AND CONCLUSIONS

74

BIBLIOGRAPHY

,76


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Federal Reserve Bank of St. Louis

ILLUSTRATIONS
A. Approximate Short-Term Rates (Daily Average)
B. Work Sheet for Computing Reserve Position (B-93)
C. New York "Money Market" Rates
D. Repurchase Agreement (With Customer)
E. Safekeeping Receipt - Repurchase Agreement
F. United States Treasury Bill
G. United States Treasury Note
H. United States Treasury Bond
I. Twelve Federal Land Banks Bond
J. Commercial Paper
K. Bankers' Acceptance
L. Negotiable Certificate of Deposit
M. History of the Prime Rate
N. Loan Participation Certificate
0. Number and Type of Notes Processed for Member Banks
P. Borrowing Resolution (BD-16)
Q. M. B. C. Note Secured by United States and Agency Bonds(BD-15)
R. Temporary Loan - City of Boston
S. M. B. C. Note Secured by Eligible Paper (BD-3)
T. Application for Advance Secured by Eligible Paper(BD-3A)
U. M.B.C. Note Secured by Municipal Bonds(BD-97A) Section 10(b)
V. Application for Advance Secured by Municipal Bonds(BD-97)
Section 10(b)


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Federal Reserve Bank of St. Louis

CHAPTER I
PURPOSE
The purpose of this paper is to acquaint member country banks
and others with the various sources of short-term credit and the
several investment outlets for short-term funds as a means, on the
one hand, of insuring the ready availability of reserve funds to meet
temporary and seasonal needs and, on the other, of providing
profitable employment of excess reserve funds in order to maximize
earnings. In particular, a brief description of the nature and purpose
of so-called "money market instruments" will be presented, as the
use of these near-money assets has become increasingly important in
the efficient management of a bank's money position and required
reserve account. A portion of a commercial bank's deposits tends to
be volatile in varying degrees and, for this reason, a bank should plan
to be in a position to convert quickly a portion of its assets into cash,
either through outright sale or by pledge of assets to secure
short-term borrowing at the lowest going rate. While the larger
country banks are presumed to be familiar with the money market,
experience suggests that many of the smaller country banks would
profit from a review of the available sources of short-term funds and
outlets for employing excess funds in short-term earning assets with a
minimum of risk.
In the following pages we shall first review briefly the nature of
reserves maintained by member banks at the Federal Reserve Bank,
the method of computing the reserves that are required by law to be
maintained (either at the Reserve Bank or in vault cash), and the
nature and significance of excess reserves.
Next, the paper will describe a number of "money market
instruments" and will outline the basic procedure of their use in the
banking system and, in particular, in the management of the reserve
position of a country member bank. In recent years an increasing
number of banks has discovered the Federal Funds market as both a
source of reserve funds and an outlet for the investment of excess
reserves. Many others adjust their positions through the purchase and
sale of Treasury Bills. The most important money market
instruments, in addition to Federal Funds and Treasury Bills, include
bankers' acceptances, commercial paper, and negotiable certificates
of deposit. The increasing volume of Federal Funds transactions, and


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Federal Reserve Bank of St. Louis

SHORT-TERM RATES - Illustration A
FEBRUARY 2, 1970
APPROXIMATE SHORT-TERM RATES
(Daily Average)

Date

Discount Rate

Prime Rate

4 to 6 Months
Commercial Paper*

Treasury Bills

1945

/
1
2to 1

1Y2

.75

.37
.37

1946

1

11
/
2

.81

1947

1

1%

1.03

.60

1948

11
/
2

2

1.44

1.04

1949

11
/
2

2

1.48

1.10

1950

1%

2%

1.45

1.22

1951

1%

3

2.17

1.55

1952

1%

3

2.33

1.76

1953

2

3/
1
4

2.52

1.93

1954

Fed Funds

1V2

3

1.58

.95

1955

2V2

3/
1
2

2.18

1.75

1.78

1956

3

4

3.31

2.65

2.73

1957

3

4/
1
2

3.81

3.26

3.11

1958

2/
1
2

4

2.46

1.83

1.57

1959

4

5

3.97

3.40

3.30

1960

3

4/
1
2

3.85

2.92

3.22

1961

3

4/
1
2

2.97

2.37

1.96

1962

3

4%

3.26

2.77

2.68

1963

3/
1
2

4/
1
2

3.55

3.15

3.18

1964

3V2

4/
1
2

3.97

3.54

3.49

1965

4

4/
1
2

4.38

3.95

4.08

1966

4/
1
2

5%

5.55

4.88

5.07

1967

41/4

534

5.11

4.32

4.23

1968

51/4

64

5.89

5.35

5.66

1969

574

8

7.85

6.75

8.20

PEAK

6

8/
1
2

9.12

8.10

12.00

*Averages of daily offering rates of dealers


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

11

purchases and sales of Treasury Bills and other "money market
instruments" has greatly expanded the volume of funds cleared
through the Wire Transfer Department of the Federal Reserve Banks;
for example, on an average day over $900 million are transferred
through the Federal Reserve Bank of Boston.
The money market is located in lower Manhattan, covering about
seven blocks, on streets named Cedar, Pine, Liberty, Nassau, Broad,
Williams, Beaver, and Wall. In this area is the New York Stock
Exchange, the commodity dealers, the municipal and corporate bond
dealers, and the investment bankers; also the following, with which
we will be principally concerned: the large money market banks, the
dealers in U.S. Government securities and the Open Market Account
at the Federal Reserve Bank of New York.
The use of a correspondent bank, both as a source of credit and as
an outlet for excess funds, will also be discussed. Finally, we will
review the function of the Federal Reserve discount window as a
basic source of credit for temporary adjustment of the reserve
account.


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Federal Reserve Bank of St. Louis

CHAPTER II
RESERVES
Description of Required Reserves
Commercial banks are required by law and custom to hold as
reserves an amount of uninvested funds, or in some cases specified
securities, equal to a certain percentage of their deposits. As of this
writing, member banks in the Federal Reserve System are required to
maintain reserves in the form of balances at the Federal Reserve
Bank and/or currency and coin in their own vaults at least equal to
the following percentages of demand and time deposits:

Reserve City Banks
Demand Deposits up to $5 million

17 %

Demand Deposits in excess of $5 million

171
2%
/

Time Deposits up to $5 million

3%

Other Time Deposits

6%
Country Banks

Demand Deposits up to $5 million

2%
/
121

Demand Deposits in excess of $5 million

13 %

Time Deposits up to $5 million

3%

Other Time Deposits

6%


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Federal Reserve Bank of St. Louis

14

THE RESERVE POSITION

At the present time, reserve requirements are established by the
Board of Governors within the following range:

Reserve City Banks
Minimum

Maximum

10

22

3

10

Minimum

Maximum

Demand Deposits

7

14

Time and Savings Deposits

3

10

Demand Deposits
Time and Savings Deposits

Country Banks

Both city and country banks' reserve periods end on Wednesday.
It is not necessary for a bank to maintain its required reserve each
day as long as its average reserves equal the required reserve for the
7-day period.
The major part of member bank required reserves is in the form of
deposits (reserve balances) at the Federal Reserve Banks. Currency
and coin held in the vaults of a member bank may also be counted as
legal reserves. For the individual bank, reserve balances serve as
clearing accounts. Member banks may increase their reserve balances
by depositing checks, currency, or by having a corespondent bank
transfer by wire funds to the reserve account. Likewise a bank may
draw against the account by authorization to charge for the payment
of a cash letter, the purchase of securities, a draft on the Federal
Reserve Bank, or by transfer of funds to another bank either in a
bank's own Federal Reserve District or some other district. In many
respects, reserves are similar to any individual or corporation
balances maintained at their commercial bank.


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Federal Reserve Bank of St. Louis

McCARTHY

Methods of Adjustment...

15

Computation of Reserve Position
On September 12, 1968, the method of computing reserve
requirements was changed so that all member banks would settle
weekly, using average close-of-business deposits two weeks earlier, in
calculating the weekly average required reserves for the current
period. This change appears to have had both advantages and
disadvantages for the member banks.. On the one hand, a bank
knows prior to the beginning of each reserve period what its reserve
requirement is for that period; and this removes uncertainties and
deadlines existing under the former method when required reserves
were computed against deposits held in the same period. On the
other hand, the two-week "lag" has created a problem in the timing
of available funds for many banks, particularly during periods of
declining deposits when the higher reserve requirement calculated
against deposit levels prevailing two weeks earlier must be met in
subsequent periods when flows of available funds are reduced
because of the deposit withdrawals.
The Federal Reserve Bank of Boston distributes to its member
banks a form entitled "Work Sheet for Computing Cumulative
Reserve Position," Form No. B-93. This form is made up in three
sections:
(I) Deposits and vault cash
(2) Reserve requirements for current period
(3) Computation of reserve position for current period
I think it would be well to briefly discuss Section (1), and I believe
Sections (2) and (3) are self-explanatory.
Gross Demand Deposits
Column 1 - Should include deposits of commercial banks, both
member and nonmember, mutual savings banks, and balances in
foreign countries.
Column 2 - Should include deposits in your treasury, tax and loan
account, proceeds from U.S. Bond subscriptions, proceeds from sale
of U.S. Savings Bonds, withheld income, Federal and Social Security
tax deposits.


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Federal Reserve Bank of St. Louis

COMPUTING RESERVE POSITION — Illustration B
1

Reserve Period No

B-93

WORK SHEET FOR COMPUTING CUMULATIVE RESERVE POSITION—PERIOD ENDING
PERIOD 2

PERIOD 1
BASE PERIOD
ENDED

PERIOD 3

PRIOR PERIOD
ENDED

CURRENT PERIOD
ENDING

12/31/69

12/24/69

1/7/70

PERIOD 4
NEXT PERIOD
ENDING

1/14/70

1/7/70

STEP 1
DEPOSITS AND VAULT CASH . BASE PERIOD FROM

Ava

D

DATE

GROSS DEMAND DEPOSITS
DEPOSITS OF US GOVT
DEMAND
BANKS
DEPOSITS

December 18, 1969

DEDUCTION ALLOWED IN
COMPUTING RESERVES
CASH ITEMS
IN PROCESS
OF
COLLECTION

OTHER
DEMAND
DEPOSITS

"L

THOUS

MILL.2THOUS NOLL

.3THOuS

mILL. THOuS

'
'•'.

Cr

360

2 010

23 800
24 490

1 860

1 880

26 050

2

2 19 ....

1 900

1 870

26 210

II" I ,!•,-

OTHER
TIME
DEPOSITS

CASH IN

BUSINESS

IMILL.
5 THOuS MIL L t
- THOUS

3 630
3 480

18 THUR

CORP.ENCY
ANI, chit!
SAVINGS
AND CLUB
DEPOSITS

"mu''.
'

BALA14CF1 AT CLOSE
MILL

NET
DEMAND
DEPOSITS

DEMAND
BALANCES
DUE FROM
BANKS

TO December 24. 1969

81,,,

MILL

SAT.

1 900

1 870

26

210

2 010

3 480

24 490

21 s,m.

1 900

1 870

26 210

2 010

24 490

5 22 .....

1 900

1 870

26 210

2 010

800

1 290

26 605

2 920

24 490
23 395
23 766

8 040
7 890
7 890
7 890
7 890
8 100
8 350

2 910

2 290

168 921

56 050

22 790

14 220

24 132

8 007

3 256

2 031

1

3 20

4
6

23

1 580

1 200

26 746

2 540

3 480
3 480
3 380
3 220

12 840

11 850

184 241

15 860

24150

1

TUES

7 24 .E.,
,7:5
'
8'
T 07'

6

ROuND TO

rHE NE ARES

THOUSAND WHEN DIVIDING THE TOT ALS

FROM COLUMNS (5. T. • • 9 BY SEVEN TO OBT AIN DAILY

AVER•GES

D•ILY
AVERAGES

3 200
3 350
3 350
_34.350
3 350
3 220

2 110
1 880

1 880
1 880
_1 880
2 300

STEP 2
RESERVE REQUIREMENT FOR CURRENT PERIOD
NET DEMAND
DEPOSITS
OVER *

NET DEMAND
DEPOSITS
'
UP 10

Lu

5

Million

;5

11

10

DEVOUT PP:RAGES
• FROM Slit' I. LINE 9,

1I

RESERVE PERCENTAGES*

12

AVE REQUIRED RESERVES
JUNE U. X LINE I I)

..LL.

THOuS

5 000 o
191
KIILL.

3.2i
THOUS

625 0

m

...ILL.

THOUS

. (X)

13

mILL.

THOUS

II

II

5 Million
14

I

THOI/S

OTHE P TIME
DE POSITS
(1VER *

E 5 Million
IS

THO,,S‘ H

m I. L

MILL.

THOL/S

11

M.LL. rifous

2_487 1

r.

fn.-..

T ri,,,S

240 2

TOT AL AVERAGE REQUIRED RESERVE (ACCUMULATE AMOUNTS ON LINE 121

14

LESS: AVERAGE CURRENCY AND COIN (FROM STEP 1 COLUMN 9 LINE 9)

•,

1 6

....._.

T.
,
.,

-

97 7
450
_

AVERAGE NET REQUIRED RESERVE (NET OF LINES 13 AND 14/ (CHECK TO RELATED FORM B- 89, COLUMN (7)

*,..e. DEROSIT

-

l',

I

8 Da7 o
3 256 o
, x
3
5 Ix,
3 - X

13

15

13

12

THDus

19 131 6
IX)

H

OTHER T NIDEPOSITS
UP TO*

Million

10
mILL.

3

SAVINGS
AND CLUB
DEPOSITS *

0

2 031 0
i

1.9 0

BASES •NC1 RESERVE PERCENT AGESPRESCRIBED IN CURRENT SUPPLEMENT TO REGUL ATION D

STEP 3
COMPUTATION OF CUMULATIVE RESERVE POSITION
To January 7, 1970 CURRENT PERIOD
'
II RESERVE PERIOD FROM January 1, 1970

in

16

CARRY OVER FROM PRIOR PERIOD 2, (USE ESTIMATE UNTIL RECEIPT OF B. 89A (ITEM G) ON FRIDAY OR MONDAY)

17

DAILY AVERAGE RESERVE BALANCE NEEDED AT F.R.B. (LINE (5 PLUS DEFICIENCY OR MINUS EXCESS FROM LINE 16)

16
co.ourE
,

DAILY BEGINNING THURSDAY OF
RESERVE WEER

.

19

RESERVE BALANCE FROM DAILY
FEDERAL RESERVE STATEMENT
NET AS OF" ADJUSTMENTS

H __MILL.

THOUS

19
5 0.,

Jan.

NION.
H

527 6

5 080 3

6

5 080 3
4 257 3

20
6 0.,. Jan. 7

uES

MILL. THOUS

li

1 308 2

MILL

THOuS

1

253 5

1

KLO
MILL

THous

,..

1 499 B

(SEE DET AILED INSTRUCTIONS,

TOTAL RESERVE AVAILABLE

20

FRI. SAT.SUN.

MILL. THOUS

1

18

..„4an. 2-34„,Jen.

THuRS

ISEE INSTRUCTIONS FOR LINES IS 231

18

17

...Jan. 1

0
1 419 0

Ika., i, rm,EB

1 527

INE T Of LINES IP • 1.1

4,
13,
AI, A,
NF,
C
,
E,.,NLE,EDE0
,
,
ER
21 0Z_Y,
DAILY EXCESS OR DEFICIENCY
22
23 CUMULATIVE EXCESS OR DEFICIENCY
NET OF L IN, S 2, 6 21,

e A,C uN1

AM.Ur• Is ON LINE

22,

1 419 0
+

108 6

+ 823

4-

108_6

+ 932 4

3

1 308

253 5

1 499 8

1 419 0

1 419 0

1 419 0

110 8
+ 821 6

-165 5

+ 8o 0

+ 656 1

+ 736 19

-

2

**Divide by 7 to compare with Item H shown on Reserve Computation Statement, Form B-89 A, which should reach member banks
on Friday 01 Monday of each week. ** $105,400 per day


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

17

Column 3 - Should include all demand deposits of individuals,
partnerships, corporations, city and town - treasurers, Federal credit
unions and cooperative banks.
Allowable Deductions from Gross Demand Deposits
Column 4 - Deduct cash items in process of collection, i.e., checks
forwarded to the Federal Reserve Bank for collection or checks
forwarded to your city correspondent, redeemed U.S. Savings Bonds,
other U.S. securities, corporate and municipal bonds or any other
item your bank has redeemed.
Column 5 - Deduct balances subject to immediate withdrawal due from banks, i.e., funds your bank has on deposit with
correspondents. Obviously you should exclude balances at the
Federal Reserve Bank.
Column 6 - Net demand deposits. This is a computed entry which
is made up of the total of columns 1, 2, and 3, minus the total of
columns 4 and 5.
Savings and Other Time Deposits
Column 7 - Should include all savings deposits of individuals or
corporations not operated for a profit, savings of trust funds or
school districts, and Christmas and vacation clubs.
Column 8 - Should include time certificates of deposit, other time
deposits of individuals, corporations, partnerships and trust funds.
Also included should be deposits of states and political subdivisions
and commercial banks.
Column 9 - Should include currency and coin held in banks' own
vaults plus cash in transit to and from the Federal Reserve Bank.
Depending upon policy of top management, the person handling
the money position should study the bank's position closely so that
he keeps all available excess funds employed at the best rate offered
in the money market, or should he have a cumulative deficiency,
action should be taken to eliminate the deficiency. In the event of a
deficiency, a bank may transfer funds from its correspondent, buy


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Federal Reserve Bank of St. Louis

THE RESERVE POSITION

18

Federal Funds, sell Treasury Bills, borrow at the Federal Reserve
Bank, or use some other quick method of securing funds. In the
event of a cumulative excess, several alternatives are available, i.e.,
sell Federal Reserve Funds, buy U.S. Treasury Bills, offer repurchase
agreements, etc. Money market instruments will be discussed in
detail in a subsequent chapter.
Excess Reserves
Excess reserves of a member bank are the amount by which
average daily reserves maintained exceed required reserves during a
weekly period. Inasmuch as they are nonearning assets, it has become
increasingly important in the high interest rate climate of recent
years for a member bank to keep excess reserves at a minimum. This
is accomplished first by closely following the cumulative reserve
position during each weekly period and second by adjusting assets
and liabilities to hold excess reserves to the lowest feasible minimum
working balances. Some banks are more efficient than others in the
management of their reserve positions and, generally, the large and
medium size banks are able to follow their reserve balances more
closely than the smaller banks. Approximate average percentage
ratios of excess reserves to required reserves for country member
banks in the First Federal Reserve District are as follows:
Total
Deposits

Percent of
Excess Reserves

Over $100 million

1.43%

$50 million to $100 million

1.38%

$25 million to $50 million

1.21%

$10 million to. $25 million

2.42%

Under $10 million

21.90%

In evaluating the significance of the foregoing ratios, it is
important to keep in mind that an excess of $10,000 will constitute
only a fraction of 1% of the required reserve of a large bank while it
will constitute a substantial portion of the total required reserve of a
very small bank.


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

19

For a number of years, the Federal Reserve Bank of Boston has
endeavored to guide its smaller banks along the lines of holding
excess reserves to a reasonable minimum. This program has included
presentations at the functional cost seminars, discussions by bank
relations representatives during their visits to individual banks and, in
some cases, suggestions made in the process of administering the
discount window when the figures disclosed that a bank was
borrowing substantially more than it needed with the result that it
was running high excess reserve balances. The Reserve Bank has
provided instructions and advice on computing the cumulative
position during a weekly reserve period, has suggested appropriate
outlets for employment of short-term excess funds such as the
Federal Funds market or U.S. Treasury Bills, and has acquainted
many banks with its service of placing orders with dealers for the
purchase or sale of U.S. Government and Agency securities at the
best market price. The latter service will be discussed in more detail
in a later chapter.
Monetary Policy and Bank Reserves
The Federal Reserve System, under leadership of the Federal
Reserve Board of Governors, uses three basic tools in effecting
monetary policy: open market operations, reserve requirements, and
the discount rate.
The System's most important policy-making body is the Federal
Open Market Committee, composed of the Board of Governors, the
president of the New York Reserve Bank, and four other Reserve
Bank presidents in annual rotation. The Committee meets regularly
to review national economic developments and to determine
monetary policy, particularly open market operations - the System's
purchases and sales of government securities in the nation's securities
market, centered in New York City.
The daily action of the desk at the Open Market Account in New
York can significantly influence the flow of bank reserves. The desk
implements the monetary policy set forth by the System Open
Market Committee. Open market operations are conducted on a
daily basis and can create reserves through purchases or absorb
reserves from the system by sales of government securities under
policy directive of the Open Market Committee. For example, the
Federal Reserve System, through the trading desk at the Federal


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Federal Reserve Bank of St. Louis


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Federal Reserve Bank of St. Louis

FEDERAL FUNDS

OPEN

81/2

HIGH

LOW

12

71/2

DISCOUNT RATE - FRB of Boston - Effective April
PRIME RATE - Effective June

CLOSE
12

8, 1969
8 1/2%.

9, 1969

DEALERS RATE - For borrowing on U. S. Government Securities

9 1/4 - 9 1/2%
7 88%

YIELDS ON - 90-day Treasury Bills - offered price
RATES ON - Dealer - Commercial Paper -

4 to 6

RATES ON - Bankers Acceptances - 30 to 90 days
91 to 120 days
RATES ON - Certificates of Deposit (Secondary market)

8 1/2 - 9%

months

Bid
7I/2%

Offer

8 3/8%
8 5/8% 8 3/4%

3 months
6 months

NEW YORK MONEY MARKET RATES, WEDNESDAY,FEBRUARY 4, 1970
Illustration C
DAILY QUOTATION - NEW YORK MONEY MARKET RATES

8 7/8%
9%

Methods of Adjustment

McCARTHY

21

Reserve Bank of New York, might buy for the Open Market Account
$1 million of Treasury Bills from a government securities dealer in
New York. The Federal Reserve Bank pays for the securities with a
check issued on itself. The dealer deposits this check in his account
with a commercial bank, which sends it for collection and immediate
credit to its reserve account at the Federal Reserve Bank of New
York.
The Federal Reserve System has added $1 million dollars of
securities to its assets, which it has paid for, in effect, by creating
member bank reserves. On the commercial bank's book, these
reserves are matched by $1 million of additional demand deposits
(money) which did not exist before the transactions.
Another Federal Reserve tool for releasing or absorbing reserves is
the authority to change reserve requirements. As indicated earlier,
the Federal Reserve Board determines from time to time what
appropriate reserve requirements should be, and their action can
either release or absorb bank reserves. However, required reserves are
infrequently changed.
Finally, the borrowing or repayment of borrowing at the discount
window creates or absorbs reserves; but it should be noted that this
reserve-creating facility is used only at the initiative of individual
member banks.
Apart from the foregoing reserve-creating tools of the Federal
Reserve System, reserves are also created or absorbed by fluctuations
in Federal Reserve float,1 Treasury operations, currency outstanding,
and gold flows through the international payments mechanism.

'Float results because the Federal Reserve gives credit to member banks for some checks
sent for collection before the Fed collects them.


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Federal Reserve Bank of St. Louis

McCARTHY

Methods of Adjustment...

23

CHAPTER III
FEDERAL RESERVE FUNDS
Description ofFederal Reserve Funds
Federal Funds are immediately available reserve balances at the
Federal Reserve Banks. For a number of years, and in increasing
volume and importance in the past nine years, the large city member
banks have traded Federal Funds as a means whereby a member bank
with temporary excess reserves may sell them (which is actually a
loan) as a means of earning interest on such excess balances, and a
member bank with a temporary deficiency in required reserves may
buy such balances (actually a borrowing). Sales of Federal Funds are
essentially unsecured loans made by one member bank to another
member bank. The usual Federal Funds sale is for overnight or if sold
on Friday - over the weekend - for three days. The Federal Funds
rate is generally determined by the day's trading centered in the New
York City money market banks. Prior to 1965, Funds usually traded
at a rate less than, or equal to, the Federal Reserve discount rate.
Prior to 1965, the Federal Funds market was a more simple and
quite often a lower cost alternative to borrowing from the Federal
Reserve Bank. Even when the Federal Funds rate is above the
discount rate, as has generally been the case since late 1964, many
banks prefer to buy Funds rather than visit the Federal Reserve
discount window. Recently there has been a willingness of some
banks to pay 4 percent above the discount rate for Federal Funds.
The Federal Reserve System has never openly approved or
disapproved of the use of the Federal Funds market as a reserve
adjustment mechanism. Currently, however, the System might be
said to approve informally the use of this market since it makes use
of existing reserves and tends to bring about a redistribution of such
funds. Unlike borrowing at the discount window or open market
operations, no additional Federal Reserve Bank credit is created in
Federal Funds transactions.
Selling banks on occasion prefer to use this market as an
alternative to short-term investments in commercial paper, bankers'
acceptances, brokers' loans, or. Treasury Bills, if the outlook for
short-term rates is uncertain.
The large city banks generally do not arrange transactions with
one another but use a New York Federal Funds broker or another


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Federal Reserve Bank of St. Louis

24

THE RESERVE POSITION

intermediary in New York. Among the large city banks the common
unit of trading is $1 million, although transactions are effected in
blocks of $100,000 or more.
Types of Banks Authorized to do Federal Funds
Until early 1970, member banks were permitted to buy and sell
Federal Funds with commercial banks (members and nonmembers),
Government securities dealers, savings banks (mutual and stock),
savings and loan associations, and any other firm, institution, or
organization. All such transactions were exempt from the Board of
Governors regulations.
On February 12, 1970, the Board of Governors of the Federal
Reserve System amended its regulations to narrow the category of
"Federal Funds" transactions that are exempted from its rule
governing reserves of member banks (Regulation D)and payment of
interest on deposits (Regulation Q). The main effect of the
amendments has been to bring within the coverage of the regulations
such transactions with any person, other than a bank, and its
subsidiaries, various governmental institutions, or, in certain cases, a
securities dealer. For the purpose of the exemption, a bank includes
the following:

(a)
(b)
(c)
(d)
(e)
(f)
(g)

A member commercial bank
A nonmember commercial bank
A savings bank
A savings and loan association
A cooperative bank
An Export-Import bank
A foreign bank

Some large city banks, including banks in New York, Boston,
Philadelphia, Pittsburgh, Chicago, Dallas, San Francisco, Los Angeles,
Detroit, Cleveland, and St. Louis, in addition to buying and selling
Funds for their own requirements, provide or absorb Federal Funds
as a service to their correspondent country banks and, in providing
such services, may trade in blocks as small as $50,000. The smaller
country banks in the First Federal Reserve District, when buying or
selling Federal Funds, ordinarily go to their New York or Boston
correspondent.


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCAR THY

25

One of the large city banks1 defines its function in Federal Funds
as that of a clearing house since there are three methods by which it
may handle transactions in Federal Funds:
(a) To the extent possible they will match on their books
buy and sell orders, which they receive from
correspondents.
(b) When their own reserve position is on the other side
from that of its correspondent, it will care for the
correspondent's needs out of its own position.
(c) When it is not possible to consummate transactions by
means of (a) or (b), it will use its best efforts to cover
their correspondent's needs in the national Federal
Funds market.

Mechanics of Transactions in Federal Funds
Normally, the country bank arranges to purchase Federal Funds
by telephone communication with its city correspondent. The selling
bank advises the local Federal Reserve Bank by telephone, telegram,
or teletype to charge its account and credit the buying bank. Letters
of confirmation follow the telephone calls or telegrams to the
Reserve Bank, and the buyer and seller exchange written
confirmation. The entries are reversed the next day by the buying
bank. Interest is paid by cashier's or treasurer's check or by credit to
correspondent account. No promissory note is executed, as a Federal
Funds transaction is an oral contract subject to written confirmation,
although in most instances the city correspondent and its country
bank customer sign an underlying agreement covering the terms and
conditions whereby Federal Funds transactions will be effected.
Many country banks may arrange to sell Federal Funds to their
city correspondent bank. For such transactions, the mechanics are
the same as described above for purchases with the roles of seller and
buyer reversed.

'First National Bank of Boston letter dated November 1961.


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Federal Reserve Bank of St. Louis

26

THE RESERVE POSITION

Legal Limits
Until July of 1963, the restriction imposed on national banks (and
there were similar provisions in many states' statutes) that aggregate
borrowing (except borrowing from the Federal Reserve Bank) could
not exceed 100 percent of capital stock and 50 percent of surplus
was a limiting factor in purchase of Federal Funds. When a national
bank was selling Federal Funds on an unsecured basis, it had to
consider that such sales were loans and they came under the single
borrower limitation for unsecured loans in the National Bank Act
(similar limitations still exist in many states' statutes) and thus
limited in individual transactions to 10 percent of capital and surplus
of the selling bank. However, under a 1958 regulation issued by the
Comptroller of the Currency, there was no limitation against the
selling bank provided the bank buying Federal Funds secured its
purchases with United States Government securities maturing not
more than 18 months from the date of the Fund transaction.
In its "Manual for National Banks," published in June 1963, the
Comptroller of the Currency issued the following ruling under
"Lending Limits," Section 1130, "Sale of Federal Reserve Funds to
Another Bank:"
"When a bank purchases Federal Reserve Funds from
another bank, the transaction ordinarily takes the form of
a transfer from a seller's account in the Federal Reserve
Bank to the buyer's account therein, payment to be made
by the purchaser, usually with a specified fee. The
transaction does not create on the part of the buyer an
obligation subject to the lending limit or a borrowing
subject to 12 U.S.C. 82, but is to be considered a purchase
and sale of such funds."
The foregoing ruling has been interpreted to mean that in the
opinion of the Comptroller of the Currency there is no legal limit to
the amount a national bank may buy or sell in the Federal Funds
market.
However, it continues to be the position of the Board of
Governors that, for purposes of provisions of law administered by
the Board, a transaction in Federal Funds involves a loan on the part


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

27

_
of the "selling" bank and a borrowing on the part of the
"purchasing" bank.
It is estimated that Federal Funds purchased by member banks in
the year 1969 in the First Federal Reserve District on a daily average
amounted to $600 million, while the average for the United States
was about $4.5 billion.


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Federal Reserve Bank of St. Louis

CHAPTER IV
REPURCHASE AGREEMENTS OR "BUY BACKS"
Agreements with Dealers
The United States Government securities market is one of the key
financial markets in this country. Practically all of the transactions in
this market are effected through a group of dealers who make
markets by buying and selling securities for their own account. For
such a market to function effectively, dealers must be willing and
able to maintain sizeable inventories of securities to accommodate
customers in situations where there are , no immediate offsetting
transactions. Since the nonbank dealers' positions are carried largely
on borrowed funds, the cost of financing is a major consideration.
The search for relatively cheap sources of financing is a key factor on
a day-to-day basis. The most common method of borrowing by the
nonbank dealer is through a "repurchase agreement" with money
market banks, other banks, insurance companies, or large
corporations.
A "repurchase agreement" permits the employment of temporary
funds overnight, for a specified number of days, or occasionally for a
month or more, at a fixed rate of interest, without any risk of loss
from market fluctuations in the securities involved. It is a
simultaneous agreement (sometimes referred to as a "buy back") by
the dealer to sell and subsequently repurchase, and by the investing
bank to purchase and subsequently resell to the dealer specified
securities, generally U.S. Government securities with maturities not
in excess of 18 months.
To cite a typical transaction, in response to a dealer's inquiry, a
bank might offer to buy a certain amount of securities at a stated
price and an agreed rate, usually based on money market rates
prevailing that day including the Federal Funds rate, dealer loan rates
and, to a lesser extent, the rate on short-term Treasury Bills.
Generally, the price is determined by the bid side of the market. The
securities are delivered to the investing bank or its designated
depository (usually a New York city bank) against payment and


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Federal Reserve Bank of St. Louis

30

THE RESERVE POSITION

subject to simultaneous agreement to resell the same securities to the
dealer with redelivery and payment to be made on the maturity date
of the repurchase contract. The selling dealer reserves the right to
exchange the securities for comparable market issues throughout the
term of the agreement. All purchases and sales are consummated in
Federal Reserve funds at the termination of the agreement, and the
investing bank receives an interest payment for the number of days it
has held the securities. At the time the repurchase transaction is
arranged, the buying bank receives two confirmation tickets - one
covering the initial purchase of the securities and the other the
repurchase by the dealer. These confirmation tickets indicate
pertinent data on the transaction including the price, the delivery
date and the interest rate. During the term of the agreement, the
bank, in addition to holding the securities, as further protection
holds the repurchase contract of the securities dealer.
Another method by which dealers may finance their inventory
positions is to borrow at call from a New York money market bank
with securities pledged as collateral.
Finally, the Federal Reserve Bank of New York may provide
dealer financing through repurchase agreements if it is deemed
desirable in conjunction with the Fed's open market operations and
conditions in the money market at that time.
Agreements with Bank Customers
As a source of funds to member banks on the one hand and, on
the other, as a means to bank customers of deriving a higher income
than permitted on deposits of less than 30 days, many banks have
entered into repurchase agreements with their customers. Repurchase
agreements of this nature are restricted to direct obligations of, or
obligations that are fully guaranteed as to principal and interest by,
the United States or any agency thereof. The bank's customer would
probably indicate he has funds to invest at a competitive rate for a
relatively short period of time. By letter, the selling bank would
confirm to its customer a complete description of the transactions,
i.e. par amount, rate and maturity, and the confirmation of the
repurchase at a future date. The number of days, rate and total
earnings would also be indicated in the letter. A nonnegotiable


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

31

safekeeping receipt would be attached and addressed to the buyer,
signed by an authorized official of the selling bank. The safekeeping
receipt would indicate whether the bonds were held at the Federal
Reserve Bank under book entry or held in the vault of the selling
bank. These repurchase agreements have proven to be most beneficial
to banks' customers, as they have been a means of employing funds
for periods of from 5 to 30 days or longer at higher rates than those
permitted under the provisions of the Federal Reserve's Regulation
Q. They have also been another source of funds to the banks during
the money "crunch" of 1969.


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Federal Reserve Bank of St. Louis

REPURCHASE AGREEMENT — Illustration D

DOLLAR NATIONAL BANK
QUINCY, VERMONT

February 2, 1970

Mr. Roger W. Brown
Rockwell Lumber Company
Rockwell, Vermont
02295
Dear Mr. Brown:
In accordance with your instructions we confirm having sold you
100,000. U. S. Treasury Notes 5% due November 15, 1970'
owned by this bank at par flat for delivery and payment on
February 2, 1970
The securities will be held by us in safekeeping for your account.
We enclose our Safekeeping Receipt No. 986555
We also confirm the purchase from you of the above securities for
delivery and payment on February 17, 1970
. At that time
we will remove the securities from safekeeping and credit your
account for the above amount plus interest or forward our Cashier's
Check at your request.
The effect of this transaction will be earnings of $
328.77
for the period February 2 to February 17
which represents
8
% per annum on the amount invested for 15
days.
We appreciate the opportunity to be of service.
Very truly yours,

Ce44(44494uthe
Alexander W. McDonald
Vice President

ii


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Federal Reserve Bank of St. Louis

SAFEKEEPING RECEIPT-REPURCHASE AGREEMENT — Illustration E

NON NEGOTIABLE SAFEKEEPING RECEIPT NO.

DATE:

To:

986555

February 2, 1970

Rockwell Lumber Company
Rockwell, Vermont
02295

Face Amount
$100,000

Description

Certificate or Bond Nos.

Treas. Notes 5% due 11/15/70

FRB BE # 320008

In accordance with your instructions these items have been placed in
safekeeping for your account.

0

1-61frf
Auth rizedfiXnature


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Federal Reserve Bank of St. Louis

.1i/

Vice President
Title

CHAPTER V
SECONDARY RESERVES
The assets known as secondary reserves are short-term government
securities, bankers' acceptances, commercial paper, brokers' loans,
negotiable certificates of deposit, and any other liquid asset that may
readily be converted into cash.
Description of Treasury Obligations
With reference to U.S. Government securities, there are four
different classifications: Treasury Bills, certificates of indebtedness,
Treasury Notes, and Treasury Bonds. Treasury Bills are issued on a
discount basis, and the rates are set by investors who tender bids for
the securities. Ordinarily, they run for three, six, nine, or twelve
months, except for special issues such as tax anticipation issues that
may run from 150 to 200 days. Bills are bought by banking
institutions for very short-term investments to take care of
unexpected rises in deposits that may remain on deposit for an
indefinite length of time or to invest short-term funds for a definite
period of time. Certificates of indebtedness' are issued for periods of
up to one year. Unlike bills, they have coupons attached which
specify a fixed rate of return. Their investment purpose is not too
different from that of Treasury Bills except that banks may buy
them for specific needs such as Christmas Clubs, Vacation Clubs,
mortgage tax accumulation, etc. Notes and bonds are very similar,
both having coupons attached. About the only difference is that
notes have a one- to seven-year maturity, and bonds may run as high
as 35 years or more. Government securities are the most marketable
of any security and can be sold for "cash delivery" the same day.
Purchase and Sale of Treasury Bills
In their modern form, U.S. Treasury Bills were first offered in
1929. The first issue, for $100 million, was sold in December 1929
and had a maturity of 90 days.
New offerings of three- and six-month bills are made each week by
the Treasury. Ordinarily subscriptions or bids are invited on
'None outstanding at the present time.


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Federal Reserve Bank of St. Louis


https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis

d

vif.5

417
Nc

•••".,

159836A
• 1.

12:N.1,114.11Ar11%,1',;
Or.1311:111CA

11102
41)

Lys
ON PRESENTATION OF THIS TREASURY BILL TO THE
TREASURER OF THE UNITED STATES OR TO ANY
FEDERAL RESERVE BANK THE UNITED STATES OF
AMERICA WILL PAY TO THE BEARER

ONE MILLION DOLLARS

TREASURY DEPARTMENT
WASHINGTON

WITHOUT INTEREST ON THE DUE DATE HEREON
SPECIFIED. THIS TREASURY BILL IS ISSUED UNDER
AUTHORITY OF THE SECOND LIBERTY BOND ACT, AS
AMENDED, IN ACCORDANCE WITH, AND SUBJECT TO,
THE PROVISIONS OF TREASURY DEPARTMENT CIRCULAR NO.418,REVISED,TO WHICH REFERENCE IS MADE
FOR A STATEMENT OF THE RIGHTS OF HOLDERS, AS
FULLY AND WITH THE SAME EFFECT AS THOUGH
HEREIN SET FORTH. THIS TREASURY BILL IS ISSUED
BY A FEDERAL RESERVE BANK OR BRANCH PURSUANT
TO A TENDER ACCEPTED BY THE SECRETARY OF
TREASURY. IT SHALL NOT BE VALID UNLESS
ISSUE DATE AND THE MATURITY DATE ARE ENT
gri
HEREON.

40*-4.4•."....../"6"........4.97,
SECRETARY OF THE TREASURY/

,
"-,/
-•r••=7

ISSUE DATE
MAY 22, 1969
DUE
AND
PAYABLE
NOV. 20 1969

,41)I•,4.01

.
4„i.j'40 44

:oh
.

"

ttST1.11'S'Or1)1F111C
FOR VALUE RECEIVED PROMISES TO PAY TO THE BEARER THE SUM OF

110101LIZI41161

,1. 3.

ON MAY IS. ISM. AND TO PAY INTEREST ON THE PRINCIPAL SUM FROM THE
DATE HONED?, AT SHE RATE OF SIX AND ONE-HALF PERCENT PER ANNUM,
PATAJLE SEMANNUALLY ON NOVEMBER IS. 1.69, AND THEREAFTER ON MAY IS
AND NOVEMBER 15 IN EACH YEAR UNTIL THE PRINCIPAL AMOUNT BECOMES
PAYABLE, UPON PRESENTATION AND SURRENDER OF THE INTEREST COUPONS
HERETO ATTACHED AS THEY SEVERALLY MATURE, ASTIR TREASURY DEPARTMENT,
WASHINGTON, D. C.. OR, AT THE HOLDER'S OPTION, AT ANY AGENCY OR AGENCIES
IN THE UNITED STATES WHICH THE SECRETARY OF THE TREASURY MAY FROM TIME
TO TIME DESIGNATE F011 RISE PURPOSE. THIS NOTE IS ONE OF A SERIES 0? HOSTS
OF THE UNITED STATES. AUTHORIZED FIT THE SECOND LIBERTY MONO ACT,
AS AMENDED, ISSUES PURSUANT TO TREASURY DEPARTMENT CIRCULAR, PUBLIC
DM SERIES—NO. 4.49, DATED NAT I, IMF, AND DESIGNATED 6* PERCENT
TREASURY NOTES Of SERIES B.I SEC UNDID NOT SUBJECT TO CALL FOR REDEM
TION PRIOR TO MATURITY. THE INCOME DERIVED FROM THIS NOTE IS 5,0911IWO.
AMM.
TAXES IMPOSED UNDER THE INTERNAL REVENUE CODE Of MIL TOWEINNO,STINI
JECT TO ESTATE, INHERITANCE, GIFT OR OTHER EXCISE TAXES.11*/2,14,60.03
OR STATE, MIT IS EXEMPT FROM ALL TAXATION RADON HEREFetlyi
THE PRINCIPAL ON INTEREST HEREOF BY ANT STATE,OR UNTO
OF THE UNITED STATES, DR Irt ANY LOCAL TAXING AUTHORIV.5
ACCEPTABLE TO SECURE DEPOSITS OF PUBLIC MONEYS. IT IS DO

22293

6/
1
2%
TREASURY
NOTE
SERIES

B-1976
DATED

MAY 15, 1969
DUE

MAY 15, 1976
INTEREST PAYABLE
MAY IDAHO
NOVEMBER 15

PAYMENT OF TAXES.
WAMIHINGTON. 0, C., MAT 15, 1969.

SECRETARY OF THE TREASURY

.,........ ....
V I I tAL 111..-1 V M HI-1.1 A/

!An Nj U ti

PAY TO REARAR ON
AT THE TRCASURY
DEPARTMENT WASAIMOTON,
A OESHIMATIO ARERGY„

...At

TIrmt R.R4.od Twati-fImi Whin
RAMA
SI0.0006A% T.....ry

NOV.15,1975
$325.00

Note, Se..B-1976

22293
PAV TO SCARE At OA
AT THA TRIA•op,..


https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis

(itcl

13

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10 At An.ON
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AT TNE 'PC
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MAY 15,1976
$325.00

$10,000 61/e Treasury Not, Ser.e. 6-1976

-. .

14

1101,111
. 4111,

38

THE RESERVE POSITION

Thursdays, and the amounts of the offerings are set at that time. The
auction is usually conducted on the following Monday, with delivery
and payment on the following Thursday.
Bids or tenders in the weekly auctions must be presented at
Federal Reserve Banks or their branches, which act as agents for the
Treasury, by 1:30 p.m., New York time, on the day of the auction.
Bids may be on a competitive or a noncompetitive basis. Competitive
bids are usually made by large investors who are in close contact with
the market. (The dealers are a major factor in the bidding.) These
bids comprise the largest portion of subscriptions on a dollar basis. In
this type of tender the investor states the quantity of bills desired
and the price he is willing to pay. A subscriber may enter more than
one bid indicating the various quantities he is willing to take at
different prices. Individuals and other small investors usually enter
noncompetitive bids, which are awarded in full up to $200,000 on
both the 91-day and the 182-day bills. Noncompetitive awards are
sold at the average price of accepted competitive bids.
Subscription books at the various Federal Reserve Banks and
branches close promptly at 1:30 p.m.; and the bids are then opened,
tabulated, and submitted to the Treasury for allocation. The
Treasury first makes all noncompetitive awards. The remainder is
then allocated to those competitive bidders submitting the highest
offers, ranging downward from the highest bid until the amount
offered is allocated. The "stop-out price" is the lowest price, or
highest yield, at which bills are awarded. Usually only a portion of
the total bids made at this price is accepted. The average issuing
price, which is usually closer to the lowest accepted price than to the
highest, is then computed on the basis of the competitive bids
accepted.
Dealers in government securities provide a market for Treasury
Bills in which purchases and sales are made at net prices expressed in
terms of yield. Because of ready marketability and the relatively low
spread between bid and asked prices, Treasury Bills usually may be
sold without loss after being held for three to five days. For this
reason commercial banks utilize them for the purpose of effecting
adjustments in the money position.
Treasury Bills are issued in denominations of $10,000; $50,000;
$100,000; $500,000; and $1,000,000. The Internal Revenue Code


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Federal Reserve Bank of St. Louis

UNITED STATES TREASURY BOND 31/2% — Illustration H

31/2%

1601

TREASURY BONO
OF 1998
DATED 59108(9 5, 1960
DUE A0E618E815. 1998

TIII NITEDSTATESDFAMERillt
FOR VALUE RECEIVED PROMISES TO rwrrorme ElEARER TRE sum

or

ONE 111[711)1t1:11)THOUS.VNI)IHALLAIIS
sosAlc.PAL Sum Eno. THE OATS NT... AT THE RATE Or THAtit
ON 1.91119.11 111, .11.1., AND TO PAY INTENT. ON TNA
ON MAY IA AND NOVENTia 19, 1.1,ANC TNEREAPTEN
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UPON PRESENTATUNT AND
IN TAC11 TEAM IlArrtt. T. PRINCIPAL NeRsoF *NALL Dig PATATILT,
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MAYOR, AT TNT TATATuRT OTAANTmENT,
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DATMAO AT TNT OrTION or THE IMPLY CONSTITUTED
AND TNT Aftocilloa ARE YO OA ArPLIED To TNT PAYNTNT or
ACC.A0 IITTAN.T, 1r flr CONATITUTTO P.A. oP SOON ETTA.
11111ENTPOSITs Of PUTIL.0 MONETT.
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WooRmaroP4, D. C., Ovros. 3, 1960.
AccoNTANT Or T.

ca,

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ASMItItt9trpli

Nat 15,1934

Ill. 15, 1551

$1.750.00
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.4 0010

1601
tozt

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i

DATED OCTOBER 30, 1960


https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis

TO..
$1.
750.00
2% Trout? bad .0 0090
1
S186.1168 3/

601 - 44,,e_68

1

99

cr.t. 595. 95, 1331
S1.750.00
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1
.9100.000 3/

ck, 1601

,
,—/76
4.ig444

...

DUE NOVEMBER 15, 1998


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Federal Reserve Bank of St. Louis

TWELVE FEDERAL LAND BANKS BOND 3Y2% — Illustration I

t)

"

7.\;

P:11:
L;TT
.

APRIL 1,1910 ,
$17.50
stwo sx% op...044a t.w

WS 4,
0 .

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sl Aoci3w,4

•

24

.
,ratILS) r}
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OCT.1,1969
$17.50
h.+

CI.ain't/1. 23
E

\CI
ONS or

,,ROANtZLO AND

te.

•1OPv

FOR VALUE RECEIVM JOINTLY AND SEVERALLY PR,01,,itSE TO PAY TO THE. LIEARER THE SLIM Or

()NT" T11101'44%NI)1)(
OM APRIL I, ISTO, S
,
H

t,ST ON TAN, FISACIFAL SS.

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or• or 7,Alg„,
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ThAT Ot ANS Mt
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att.mict

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ACT, AS ATIESSIO, AT LEAST VAAL III AltOUltt

IN WITNESS WHEREOF MS
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ross worn rtArts somenostre, Aso NetTNE it IN.

A,NT, ES EXEMPT TAOS SCHAAL OS ATM TAIIATIO.„TISST

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atsrostuom or sup unto SINSTAANAPTATSCREOF

Mt SONOS ISSSAST ASO

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ALA ttOttAL LAND SAWS Aft LtAtLit sow INC PAVOISNT
l

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of TPOS SONO.

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,
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7L
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DATED FEBRUARY 14, 1958

ST

T..... FARO L.A.

1114114
,
1 fet,AVIST CO
,
L.TCSALSt.S.STT FSEACAIATS

DUE APRIL 1,1970

7,4

McCARTHY

Methods of Adjustment...

41

provides that Treasury Bills shall be excluded from consideration as
capital assets, so that the difference between purchase price and sale
price or maturity value is an ordinary gain or loss of interest income,
not a capital gain.
As a service to its member banks, the Federal Reserve Bank of
Boston will execute, as their agent, purchases and sales of marketable
securities of the United States Government (including its agencies),
with dealers in government securities. All purchases and sales are
made "at the market" on the basis of telephone competitive bids,
usually from three or more dealers. Ordinarily on the day of receipt
of a purchase or sale request from a member bank, orders are placed
for "regular" delivery on the next business day. In the event a bank
has excess funds it wishes to employ immediately, the Federal
Reserve will place orders for "cash delivery" and payment the same
day, thereby increasing the member bank's earning assets
immediately. If a bank finds itself in need of funds immediately, the
Federal Reserve will sell securities for "cash delivery" and payment
the same day, thereby putting the bank in immediately available
funds. This affords a bank the opportunity to run a close reserve
position, and country member banks have found this to be a very
helpful and convenient service.
Commercial Paper
Commercial paper is the name applied to unsecured promissory
notes issued by various companies of established financial stature to
raise money for short periods of time. It has been a means of
providing funds to American industry since the early 1800's, and has
enjoyed its greatest growth in recent years. Totals outstanding have
risen from less than $1 billion immediately after World War II to as
high as $36 billion or more recently. During the past three years
many corporate treasurers have experimented with this supplemental
financing vehicle and have found it efficient and economical. Large
numbers of medium-sized and large corporations are entering the
commercial paper market for the first time. At the same time
portfolio managers have found this paper unusually attractive and
have been rather aggressive buyers of such paper. This type of note
when due within 90 days is generally eligible for discount at the
Federal Reserve Banks.
Many transactions in commercial paper are handled through
commercial paper dealers - there is no direct contact between


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Federal Reserve Bank of St. Louis

COMMERCIAL PAPER — Illustration J

131.74

S100,000.

Boston

Massachusetts

January 28,1970
(DATE)

(CITY AND STATE)

On

we promise to pay to the order of

April 27,1970

BEARER
ONE HUNDRED THOUSAND DOLLARS
Payable at
Value Received.

The Fifth National Bank of Boston, Massachusetts

David Manufacturing Corporation

729
No. 7


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Federal Reserve Bank of St. Louis

AUTHORIZED SIGNATURE

Prebident

Methods of Adjustment

McCARTHY

43

borrower and lender. The dealer purchases the paper outright from
the borrower at a flat rate plus a commission for handling the paper.
The commission is usually 1/8 to 1/4 of 1 percent included in the net
rate to the borrower or the maker of the note. The paper in turn is
sold (at the going market rate) by the dealer on a discount basis. All
commercial paper offered by dealers is in even figures such as
$50,000; $100,000; and $500,000 notes. There are no odd or
in-between amounts issued, and the most common denominations
currently range from $100,000 to $1,000,000 and are generally sold
for delivery and payment at a bank against payment in Federal
Funds. The majority of the notes are made payable at a New York or
Chicago bank.
Notes issued for $100,000 are used mainly for investment by small
country banks as a means of splitting up the offering of borrowers
who insist upon a wide distribution of paper through the country
banks. The denominations in which paper is currently issued are
determined largely by the dealer. He. generally suggests to the
borrower the denomination to be issued, bearing in mind the size of
the borrowing concerned, the amount currently being borrowed in
the open market, the degree of distribution desired by the borrower,
and the condition of the money market. Most of the paper sold in
the open market today has a maturity of from three days to nine
months. If it is longer, the issue must be registered with the
Securities and Exchange Commission.
Dealers sometimes request the borrower to issue specific
maturities to assist open market investors to provide some known or
anticipated future demand for funds. The commercial paper market
is organized so that once the concern has become a recognized issuer
of paper, it can obtain funds with a minimum of formality and delay.
Some of the small sales finance companies still market their notes
through dealers, but most of the larger companies now sell them
directly to institutional investors, thereby creating a new market for
the mselves.
Commercial paper is bought for investment by industrial
corporations, public utilities, educational institutions, trust funds,
public funds, charities, hospitals, as well as by banks, insurance
companies and other institutional investors.


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Federal Reserve Bank of St. Louis

44

THE RESERVE POSITION

At the present time there are only about 450 firms that are
recognized as qualified issuers of commercial paper.
From an economic standpoint, commercial paper has proved its
usefulness and reliability over many years and will continue to play
an important part in serving industry, commerce and banking
because of the advantageous features this technique offers both to
the borrower and the investor.
For a national company to market its paper through dealers in the
commercial paper market, it should be able to comply with the
following requirements:
a. Substantial working capital.
b. Comfortable current ratio of assets to liabilities.
c. Proper bank relations.
d. Favorable record of earings, net worth and working capital.
e. Proven ability and character of management. The dealer, of
course, acquaints the potential buyer of commercial paper with
character of management; organization of company; present
policies; history; current outlook; and its latest statement and
financial standing.
Commercial paper is an excellent secondary reserve, provided that
the investing bank can pinpoint its maturities. Unlike Treasury Bills,
commercial paper is hard to sell prior to maturity; as there is no
formal secondary market for commercial paper. In the event that the
bank is in a liquidity squeeze, it has two alternatives, either to sell
the commercial paper to a correspondent bank, or providing it is
eligible, to pledge it to a borrowing from the Federal Reserve Bank.
The rapid growth of this market has had a sharp impact on the
commercial banks. Developments in dealer paper suggest a strong
movement away from commercial bank financing. Several new
borrowers (such as public utilities) have entered the market; and up
until recently, these firms did not issue commercial paper but relied
principally on commercial banks for their financing.


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Federal Reserve Bank of St. Louis

McCARTHY

Methods of Adjustment...

45

Bankers'Acceptances
A banker's acceptance is a time draft or bill of exchange which has
been drawn on and accepted by a bank, trust company or other
institution engaged primarily in the business of banking. When
accepted, such a draft becomes an unqualified promise by the
accepting bank to pay the draft at maturity.
Member banks of the Federal Reserve System are authorized by
the Federal Reserve Board (Regulation C) to accept commercial
drafts and bills up to 50 percent of their paid up and unimpaired
capital stock and surplus; except that with permission of the Board
of Governors any such member bank (approximately 68 banks) may
accept such drafts or bills up to 100 percent of such capital and
surplus, but the aggregate of such acceptances growing out of
domestic transactions shall in no event exceed 50 percent of such
capital and surplus. In addition, some member banks (approximately
48) are permitted by the Federal Reserve Board to accept bills to
create dollar exchange up to 50 percent of capital and surplus.
Therefore, the acceptance power of a member bank for all types of
acceptances is 150 percent of capital and surplus. There is a further
limitation that acceptances, to create dollar exchange, must have a
maturity of not more than three months. All other types may have a
maturity of not more than 6 months.
The Federal Reserve Act authorized member banks to accept
drafts or bills of exchange drawn upon them to finance four broad
categories of transactions.
a. The import and export of goods.
b. The shipment of commodities within the United States.
c. The storage of readily marketable staple commodities, either in
the United States or in foreign countries.
d. The furnishing of dollar exchange.
The mechanics of a banker's acceptance are as follows. Stevens &
Co., a Boston wool importer, goes to his Boston bank for a letter of
credit in favor of A.J. Ashton, an Australian exporter. The letter of
credit states the details of the shipment and the credit terms and tells
Ashton that he may draw drafts on the Boston bank for $50,000,
the value of the wool shipment. Stevens & Co. agrees to put the
Boston bank in funds to cover the accepted draft at maturity.


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Federal Reserve Bank of St. Louis

BANKERS' ACCEPTANCE — Illustration K

Boston, Kass., tii.S A.,
,
o
sight
after

Oa' t
Ninpnir.5ay I;
X 0
Pay to the .noft. of

'
i
Tho Fiftti NatIonal Link wf Bos.'.*
:
;

CO

$

Date - August 1. 1965

50.000.00

1

gzt _ _.1. igrry 1,40,jsgo

no/100

Dollars

(tthe account of:
isame' ri
- 6 iii44 aceiveA onelchargeV4eW
0 .

89

"—I /.4

To:


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Federal Reserve Bank of St. Louis

E-.

c.4

P.

CO

z
Lettincof OrdO_No. mi
0
d 0
.2rt
¢
)ston
The FifklgtigtinaL Bank o
5
Bostollpsaschisetts 0
51
" 0

",

E-4 44 o c-1

,
4-

V

F

4
•,-1
rx.
0
,0
E-4

4

'
.
0
o
co
0
PI

44

)
4

A. J. Ashton
.....—.

Methods of Adjustment...

McCARTHY

47

The Boston bank cables its correspondent in Australia to tell
Ashton about the letter. Ashton then ships the wool. To make sure
that the transaction is in order, he holds the bill of lading and other
documents that will be needed in Boston to get the wool from the
shipping company. He (A.J. Ashton) draws a draft on the Boston
bank, say for 90 days after date, and presents it, together with the
necessary documents, to the bank in Australia which pays him an
amount less discount. Ashton is then pretty much out of the
transaction. The Australian bank now owns the draft and sends it
and all the accompanying papers to its Boston correspondent for
presentation to the Boston bank. When the Australian bank presents
the draft and documents, the Boston bank stamps "accepted" on the
draft as long as everything is in order. Now the Australian bank has
the Boston bank's commitment to pay the draft at maturity and can
sell what is now a "Banker's acceptance" in the market at a discount
to a dealer and have the proceeds credited to the Australian bank.
The acceptance buyer has the Boston bank's obligation to pay
$50,000 in 90 days from the date it has stamped on the bill. Now the
Boston bank gives Stevens the shipping documents,in exchange for a
trust receipt. He takes his wool, sells it, and uses the proceeds to pay
the Boston bank before the maturity date of the banker's
acceptance.
Quoted rates of discount by dealers, unless specifically designated
otherwise, are for "prime" bills - those of the banks in the larger
financial centers whose credit is well established and whose name is
known both in the open market and at the Federal Reserve Bank.
Off-prime bills are seldom traded in the open market. Occasionally, a
large bank will discount a correspondent's bills at a rate determined
by the discounting bank, usually within a range of 1/8 percent to 3/8
percent of the prime rate, and hold such bills in its portfolio until
maturity.
As to safety and high credit of the acceptance itself, it might be
sufficient to state that there never has been a loss to any investor,
and this includes the period which witnessed the banking holiday of
1933.1
Neither commercial paper nor bankers' acceptances are used very
frequently today to adjust reserve positions, but they do provide an
excellent outlet for temporary funds.
1L. Meredith

Maxson, First Boston Corporation.


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Federal Reserve Bank of St. Louis

48

THE RESERVE POSITION

Negotiable Certificates of Deposit
About nine years ago the large money market banks in New York
City and other reserve city banks began issuing negotiable certificates
of deposit in an effort to attract funds which institutional investors
had been shifting to higher income money market instruments. The
certificates are simply pieces of negotiable paper that tell large
depositors that they have a certain amount of dollars at a particular
bank on deposit. These certificates are generally issued in amounts of
$100,000 or more, although they could range from $25,000 to $10
million, depending on the size of the issuing bank and the type of CD
customer it is trying to attract. Such deposits may not be withdrawn
prior to the stated maturity date, at which time the certificate
matures and interest is paid at the rate originally agreed upon by the
depositor and the bank. Time certificates (or CD's) did not originate
in 1961, but prior to that time they represented primarily
savings-type deposits and were generally not negotiable, and of
course there was no secondary market for such paper. The offer of
certificates also represented an attempt to increase the stability of
deposits. The time deposits acquired are available to the issuing bank
for loans and investments of longer maturities. Of course, no bank is
assured that the maturing certificates will be rolled over into new
certificates, therefore suggesting the possibility of a bind for funds at
the maturity date. This was very evident during the latter part of
1969.
The most popular maturity had been in the one to three month
area, but the recent raising (January 21, 1970) of the interest ceiling
(Regulation Q of the Board of Governors of the Federal Reserve
System) has attracted some new money at the 7 1/2 percent rate
maturing in more than one year.
CD's may be in registered or bearer form, although the latter is
more convenient for secondary market trading.
The Federal Reserve's Regulation Q, which sets the maximum
rates payable on time and savings deposits, is a fundamental
consideration in the market for CD's. When short-term open market
rates rise above or even approach the prescribed ceiling, CD's cease to
be competitive in the markets. Bankers have found it increasingly
difficult to replace maturing certificates and are likely to experience
large deposit losses (as was the case in the third quarter of 1969) as
investors turn to higher yielding money market instruments.


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Federal Reserve Bank of St. Louis


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Federal Reserve Bank of St. Louis

CERTIFICATE OF DEPOSIT —Illustration L

5-23
110

ROCKWELL NATIONAL BANK
100 ADAMS STREET
MILTON, MASSACHUSerxS

JANUARY 25, 1970

No. 3135

THIS IS TO CERTIFY THAT THERE HAS BEEN DEPOSITED WITH THIS BANK
ONE MILLION
PAYABLE TO
on

DOLLARS

$ 1,000,000.

ALPHA CEMENT COMPANY

JANUARY 25

1971 with interest, to maturity only, at the rate

% per annum upon presentation and surrender of this
of 7 1/2
certificate properly endorsed at the above office of this bank, neither
the deposit evidenced hereby nor the interest thereon may be withdrawn
before maturity. Payable at the Orange Trust Company, New York,
New York, if desired.

414.4•4
S571%6444
AUT ORIZED SIGNATURE

f'lldr
"

Interest computed actual days on 360 day basis.
5745 Rev.

CERTIFICATE OF DEPOSIT

AIOR ZED SIGNATURE

50

THE RESERVE POSITION

Prior to the introduction of the certificates of deposit, corporate
funds on demand deposit with commercial banks drew no interest,
and corporate treasurers were gradually withdrawing funds from
banks and investing them in short-term investments such as U.S.
Treasury Bills and commercial paper. The growth in the amount of
negotiable time certificates was phenomenal. It has been estimated
that outstanding CD's reached a peak of $24.5 billion in the fall of
1968 and at the present time amount to $11.7 billion.
Interest is paid on the par value of the certificate and is accrued on
a 360-day basis. The rate to be paid is determined by money market
conditions and is competitive with other money market instruments.
The yield on a CD would probably have to be about 25 basis points
above Treasury Bills to attract investors.
Most of the commercial banks in the country issue CD's, but it is
estimated that the large money market banks in New York and
Chicago have issued over 50 percent of the CD's outstanding.
The principal secondary market for certificates of deposit is
centered around the trading operations of about ten U.S.
Government securities dealers in New York. These ten dealers "make
a market" and daily supply potential buyers with their daily bids and
offerings. Certificates of deposit are classified as prime, lesser-prime,
and non-prime. Certificates are designated prime simply because the
bank is big and its name well-known. A list of "so-called" prime
banks might include about 20 nationally known banks. About half of
these banks are located in New York City, several in Chicago, and
others in Boston, Philadelphia, Pittsburgh, and San Francisco.
While there may be little, if any, difference between prime and
non-prime certificates as to quality, non-prime certificates are not as
readily marketable. Prime name certificates of deposit usually trade
at rates of 40 to 60 basis points higher than rates on comparable
maturing U.S. Treasury Bills.
Some dealers prefer to trade only prime or lesser-prime
certificates, inasmuch as their customers are only interested in such
quality. Other dealers will trade certificates of some of the
"so-called" non-prime certificates. These dealers proceed under the
assumption that a buyer will probably not be found and they will be
required to hold the certificates in their possession until maturity.


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Federal Reserve Bank of St. Louis

McCARTHY

Methods of Adjustment...

51

The bid rate to the seller of the non-prime certificates will be high
enough to insure, insofar as possible, a profit on the certificate's
interest accrued after deducting the interest cost of money borrowed
to carry the certificate.
Dealers have encountered no special difficulties in borrowing to
finance their holdings of certificates of deposit. New York "money
market" banks will lend funds against certificates at the same rate
they charge for call loans secured by U.S. Government securities.
The growth and development of the CD market has provided the
money market banks with another means of reserve adjustment. In
addition to borrowing from the Federal Reserves, buying Federal
Funds, or liquidating short-term assets, a bank may now acquire
additional funds by simply raising its rate payable on CD's, provided
there is room under the ceiling set by Regulation Q. Of course CD's
were not competitive with other short-term money market rates
during 1969, but the revision of Regulation Q early in 1970 once
again placed long CD's at 7 1/2 percent in a competitive position.
The Prime Rate
Banks have always had a preferential rate for their best customers.
The prime rate concept apparently was not publicized on a national
basis until 1933. The prime rate stood at 1 1/2 percent from 1933
until December 1947. Since 1947 we have had thirty-three changes
and all such changes, with three exceptions, were initiated by large
New York "money market" banks. The three exceptions were banks
in Boston and Chicago. The current rate of 8 1/2 percent is the
highest in the history of commercial banking in the United States. At
the time of a change, a large bank officially posts such change, and in
each case it has been followed in a matter of hours by increases or
decreases by the other large banks throughout the country.
Historically, the prime rate has been in the range of one to two
percentage points above the Federal Reserve discount rate but is
currently 2 1/2 percent above it. Changes in the prime rate are
regarded by big business and the banking industry as one of the
leading indicators of credit conditions.
Changes in the prime rate do not normally occur ahead of or even
concurrently with shifts in the credit market. Rather, a change in the
prime rate may be interpreted as confirming that a shift has already
taken place and that no immediate reversal is anticipated.


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Federal Reserve Bank of St. Louis

HISTORY OF PRIME RATE - Illustration M

Banks have always had a preferential rate for their best customers. The prime rate concept
apparently was not publicized on a national basis until 1933. It stood at 1V2% until December
1947.

FEBRUARY 2, 1970
DATE

RATE

December 15, 1947
August 10, 1948

13/4%

September 22, 1950
January 5, 1951
October 17, 1951
December 18, 1951
April.27, 1953
March 17, 1954

2%
2/
1
4%
2/
1
2%
234%
3%
31/4%

August 4, 1955

3%
1 4%
3/

October 14, 1955

3V2%

April 13, 1956

33/4%

INITIATED BY
Bankers Trust Company, N.Y.
Irving Trust Company, N.Y.
First National City Bank, N.Y.
Bankers Trust Company, N.Y.
First National City Bank, N.Y.
Chase Manhattan Bank, N.Y.
Bankers Trust Company, N.Y.
Morgan Guaranty Trust Co., N.Y.
Chase Manhattan Bank, N.Y.
First National City Bank, N.Y.
Chase Manhattan Bank, N.Y.

August 20, 1956

4%

August 7, 1957

4/
1
2%

First National Bank of Boston
Bankers Trust Company, N.Y.

January 21, 1958

4%

Chase Manhattan Bank, N.Y.

April 21, 1958
September 11, 1958

3/
1
2%
4%

Morgan Guaranty Trust Co., N.Y.
Chase Manhattan Bank, N.Y.

May 18, 1959
September 1, 1959

4/
1
2%

First National City Bank, N.Y.

5%

August 23, 1960

First National City Bank, N.Y.
Manufacturers Hanover Tr. Co., N.Y.

December 6, 1965

4/
1
2%
5%

March 10, 1966

5/
1
2%

First National Bank, Chicago
Morgan Guaranty Trust Co., N.Y.

June 30, 1966

53/
4%
6%

Chemical Bank N.Y. Tr. Co., N.Y.
First National City Bank, N.Y.

53/4%
5/
1
2%
6%

First National City Bank, N.Y.
Morgan Guaranty Trust Co., N.Y.
Continental Illinois N/B, Chicago

6/
1
2%
61/4%
61/2%

Bankers Trust Company, N.Y.
First National City Bank, N.Y.
Chase Manhattan Bank, N.Y.
First National City Bank, N.Y.

August 17, 1966
January 30, 1967
March 23, 1967
November 21, 1967
April 19, 1968
September 25, 1968
December 2, 1968
December 18, 1968
January 7, 1969
March 17, 1969
June 9, 1969


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Federal Reserve Bank of St. Louis

63/4%
7%
71
/
2%
8/
1
2%

First National City Bank, N.Y.
Morgan Guaranty Trust Co., N.Y.
Bankers Trust Company, N.Y.

McCARTHY

Methods of Adjustment...

53

CHAPTER VI
RELATIONS WITH CORRESPONDENT BANKS
Loan Participations
Loan participation and the purchase and sale of loans are an
important part of correspondent bank relations. Many banks engage
in such activity as another method of adjusting their reserve
positions. For example, some of the large banks and particularly the
"money market" banks sell participation in their brokers' loans to
their out-of-town correspondents on a demand basis.
A common type of participation would originate with a country
bank requesting a larger correspondent to participate in a loan which
exceeds the legal limit of the bank making the request. Likewise, a
city bank may go to a large money market bank with the same type
of request.
Another method for a more permanent adjustment would be
outright sales from the portfolio of one bank to another. Banks with
a low loan demand may buy commercial loans from a loaned-up
bank in another area. Likewise, banks that are over-loaned may sell
or participate a portion of their loans to another bank that is anxious
to employ excess funds.
Most of the smaller banks are, at times, required to obtain
assistance from their city correspondents, but many of them are
reluctant to do so. One of the reasons is that they are afraid the city
bank will cultivate the friendship of their customer and probably
take over the account. However, in recent years the city banks have
become more aware of this situation and are pursuing a more
conservative approach and want to retain the goodwill of their
country correspondents.
Direct Borrowing
Country banks in need of temporary funds may go to their city
correspondent for such accommodation. Such requests may be made
by telephone by officials authorized to borrow in accordance with a
borrowing resolution which is kept on file at the city banks. Such
requests must be confirmed in writing and mailed the same day. Such


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Federal Reserve Bank of St. Louis

LOAN PARTICIPATION — Illustration N

$ 100,000.00

No. 11599

THE NEW BOSTON NATIONAL BANK
BOSTON, MASSACHUSETTS

NON-NEGOTIABLE LOAN PARTICIPATION CERTIFICATE

The New Boston National Bank of Boston hereby certifies that
The State Bank and Trust Company, Portland, Maine
Is entitled to a participation of
Par value in loan of
to
dated

one hundred thousand

five hundred thousand

00/100
00/100

Dollars

Dollars ($500,000.00)

Clayton Clark and Spear Corporation, Chicago, Illinois
August 1, 1965

and payable on

December 1, 1965

held by the New Boston National Bank of Boston as agent for the collection of principal and
interest thereof for the benefit ratably of the participants.

The New Boston National Bank

of Boston may hold an interest in said loan on its own account.

In consideration of the issue hereof and by the acceptance of this
participation certificate, the owner hereof expressly agrees that said New Boston National
Bank of Boston shall be free from liability of any kind on account of this participation,
except for the proportionate distribution of any amounts received by it for such distribution.

Boston, Mass.,

August 27


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Federal Reserve Bank of St. Louis

19 65
Authorized Official
V. P.

ILLUSTRATION N

Methods of Adjustment...

McCARTHY

55

loans are generally credited to the borrower's deposit account, unless
the borrower requests otherwise. In many instances the borrower has
the funds transferred to its account at the Federal Reserve Bank.
Most loans are made on a term basis, and if such loans are secured by
U.S. Government bonds, the interest charged is the same as the
current prime rate; if other types of collateral are pledged, the rate
would vary depending upon the going rates in the market and the
quality and the marketability of the collateral pledged.
This is a fast and convenient way to borrow, as the banks hold a
part of their investment portfolio with their correspondents, and it is
a simple matter to release them from safekeeping to be pledged to a
loan. There are some banks that prefer borrowing from their
correspondent on a secured basis rather than buying Federal Reserve
Funds or seeking such accommodation from the Federal Reserve
Bank.


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

57

CHAPTER VII
THE DISCOUNT WINDOW
Member banks may replenish their reserves in the Federal Reserve
Bank by discounting their own notes secured by U.S. Government
securities or other satisfactory collateral, or by discounting eligible
customer notes. In either case the proceeds are credited to the
member bank, thereby increasing their reserves. The rate of interest
charged for these loans by the Federal Reserve Bank is called the
discount rate. By raising or lowering the discount rate, the Reserve
Banks can make it more or less expensive for member banks to get
additional reserves. Access to the discount window provides assurance that in time of real need, individual banks may be able to
maintain their liquidity. Ordinarily, a need for reserve funds would
be met first by liquidation of secondary reserves as described in the
preceding chapters. The tradition against being continually in debt to
any source has tended to limit member bank borrowing. Federal
Reserve discount policy is administered by the individual Federal
Reserve Bank under the provisions outlined in the Board's Regulation A.
Foreword to Regulation A
"Access to the Federal Reserve discount facilities is
granted as a privilege of membership in the Federal
Reserve System in the light of the following general
guiding principles.
"Federal Reserve credit is generally extended on a
short-term basis to a member bank in order to enable it to
adjust its asset position when necessary because of developments such as a sudden withdrawal of deposits or
seasonal requirements for credit beyond those which can
reasonably be met by use of the bank's own resources.
Federal Reserve credit is also available for longer periods
when necessary in order to assist member banks in meeting
unusual situations, such as may result from national,
regional, or local difficulties or from exceptional circumstances involving only particular member banks. Under
ordinary conditions, the continuous use of Federal Reserve
credit by a member bank over a considerable period of
time is not regarded as appropriate.


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Federal Reserve Bank of St. Louis

NUMBER AND AMOUNT OF NOTES HANDLED FOR MEMBER BANKS BY CLASS OF BORROWING
(1959 -1969) Federal Reserve Bank of Boston

Illustration 0

Amount in thousands

Advances on U. S.
Dollar
No. of
Amount
Notes

Advances
On Eligible Paper
Dollar
No. of
Amount
Notes

Advances-Provisions
Section 10(b)
Dollar
No. of
Amount
Notes

Rediscounts
Of Eligible Paper
Dollar
No. of
Amount
Notes

Year

No. of Banks
Accommodated

1959

171

1,828

$2,878,887

1

60

1

$ 1,500

60

$380

1960

178

1,572

1,444,122

1

5,000

1

50

14

115

1961

146

745

474,876

0

0

1

206

0

0

1962

132

710

687,873

8

13,000

2

1,300

0

0

1963

127

748

1,206,233

0

0

0

0

0

0

1964

130

921

1,406,315

3

310

0

0

0

0

1965

106

801

2,699,764

0

0

0

0

0

0
0

1966

140

1,409

3,958,216

12

145,995

1

150

0

1967

96

509

1,260,574

0

0

0

0

0

0

1968

119

1,235

6,146,321

4

72,175

1

20,000

0

0

1969

150

2,646

9,499,311

83

3,287,166

26

88,375

0

0


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

59

"In considering a request for credit accommodation,
each Federal Reserve Bank gives due regard to the purpose
of the credit and to its probable effects upon the maintenance of sound credit conditions, both as to the individual
institution and the economy generally. It keeps informed
of and takes into account the general character and
amount of the loans and investments of the member bank.
It considers whether the bank is borrowing principally for
the purpose of obtaining a tax advantage or profiting from
rate differentials and whether the bank is extending an
undue amount of credit for the speculative carrying of, or
trading in securities, real estate, or commodities, or
otherwise.
"Applications for Federal Reserve credit accommodation are considered by a Federal Reserve Bank in the light
of its best judgement in conformity with the foregoing
principles and with the provisions of the Federal Reserve
Act."
Borrowings Secured by Direct Obligations of, and Obligations Fully
Guaranteed as to Principal and Interest by the United States
The Federal Reserve Banks opened in the fall of 1914, and up
until September of 1916 member banks could borrow from their
regional bank only by rediscounting eligible paper. At that time the
Federal Reserve Act was amended to permit advances secured by
either eligible paper or U.S. Government securities. This action was
related to the problems of financing World War I.
During the period from 1914 to 1934 most member banks were
familiar with the concept of eligibility. Many banks maintained
records so that they could readily determine the amount of eligible
paper in their portfolio, and the loan policy was aimed at holding a
certain percent of its loans as eligible paper that could readily be
discounted at the Federal Reserve Bank. Despite a low discount rate,
banks used the discount window sparingly between 1933 and 1951.
From 1935 to 1940 daily borrowing generally averaged below $10
million; average daily borrowings during the year 1969 averaged
$1.105 billion. For the most part, banks held large excess reserves
and were under little pressure to borrow. Even after the business
recovery of the early 40's, borrowings remained at low levels. By that


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Federal Reserve Bank of St. Louis

BORROWING RESOLUTION — Illustration P
"WHEREAS, it is desirable that the Officers of this Bank should, from time to time, be able to rediscount
its bills receivable, and to secure advances from the Federal Reserve Bank of Boston on promissory notes of this
Bank secured by collateral, as provided by the Federal Reserve Act or any other Statute of the United States and
any amendments thereto now in force or which may hereafter be made:"NOW, THEREFORE, RESOLVED, that the President, any Vice-President, and
Board, Cashier, and Assistant Cashier
(indicate by title any other authorized officers)
successors in office, be, and any

Chairman of the

, of this institution, and their

One
(indicate whether one, or two, etc.)

of them hereby jasre

authorized and empowered, in the name and on behalf of this institution, from time to time:
"I. To rediscount, with the Federal Reserve Bank of Boston, notes, drafts, acceptances, bills of
exchange, and other bills receivable, of the kinds and maturities made eligible for rediscount under the
Federal Reserve Act or any other Statute of the United States and any amendments thereto now in force or
which may hereafter be made, in such sums and upon such terms as may to them or either of them seem
advisable;
"II. To execute and deliver, to the Federal Reserve Bank of Boston, the promissory note or notes of
this Bank, secured by such notes, drafts, bills of exchange, or bankers' acceptances as are eligible for
rediscount or for purchase by Federal Reserve Banks under the provisions of the Federal Reserve Act or
any other 'Statute of the United States and any amendments thereto now in force or which may hereafter be
made, or by the deposit or pledge of bonds or notes or Treasury bills or certificates of indebtedness of the
United States, or secured as otherwise permitted under the provisions of the Federal Reserve Act or any
other Statute of the United States and any amendment thereto now in force or which may hereafter be made;
"III. In order to carry out the purposes of the foregoing votes, to endorse on behalf of this Bank,
either with or without written waiver of demand, notice and protest, any notes, drafts, bills of exchange,
bills receivable, or bankers' acceptances, whether rediscounted or deposited as security; to deposit, as
security or pledge for such note or notes of this Bank, bonds or notes or Treasury bills or certificates of
indebtedness of the United States; and to deposit, endorse, assign and/or transfer any other assets of this
Bank as security or pledge for such note or notes of this Bank; and to do any and all other acts and sign
any and all other instruments or papers necessary or advisable in the premises, including, without limiting
the generality of the foregoing, certification as to eligibility of paper or other assets rediscounted or deposited as collateral; and
that the foregoing powers shall continue until express notice of their revocation has been duly given in writing to
the said Federal Reserve Bank of Boston."
I, the undersigned, do hereby certify that the foregoing is a true and correct copy of a Resolution of the
Southern National Bank of Boston
Board of Directors of the
(Name of Bank)
Boston,. Massachusetts
,duly adopted at a regular meeting of the said Board,
(Location)
JI,me 2. 1968
held on
a quorum being present, and of the whole of the said Resolution,
as set forth in the minutes of the said meeting, and that the said Resolution has not been rescinded or modified.
IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed the corporate seal of the said
Bank this
May
24.
.day of
19
(Seal)

S.D. 16
(6-64 100)


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Federal Reserve Bank of St. Louis

ashler
Board

etary of the
irectors

Methods of Adjustment...

McCARTHY

61

time, banks held large quantities of Government securities and the
Federal Reserve's practice of pegging the market for these securities,
instituted in 1942, eliminated the market risk of adjusting reserve
positions through sales of Governments. The Treasury-Federal
Reserve Accord in the spring of 1951, however, ended the pegged
market for Government securities and began a new chapter in the
history of the discount window. As indicated by the illustration, in
the First Federal Reserve District discounting increased sharply
during the year of 1965. Inasmuch as our banks had heavy portfolios
of U.S. Governments, there was little need to be concerned with
eligible paper.
As indicated in the illustration, the borrowing from the Federal
Reserve Bank during the past ten years has been principally by
advances on promissory notes secured by direct obligations of the
United States and its agencies. Advances secured by Governments as
collateral are the most convenient way to borrow. The collateral is in
large denominations and is readily available. Most of the member
banks have U.S. Government securities in safekeeping at the Federal
Reserve Bank so they may be immediately pledged as collateral to an
advance. It is also possible for a member bank that holds its collateral
at a New York correspondent bank to make arrangements for
delivery of a trust receipt to the Boston Federal Reserve Bank. On
the day of the advance the borrowing bank would indicate to its New
York correspondent by telephone a complete description of the
securities to be pledged, and the New York correspondent would
telephone the Discount Department at the Federal Reserve Bank of
Boston to be followed by a confirming wire.
The mechanics of borrowing on U.S. Government securities are
quite simple. The member bank merely sends in its promissory note
signed by a duly authorized official, indicating the securities to be
pledged which may be held in book entry; or if definitive securities
are to be pledged, we would be advised of the number on the safekeeping receipt. Generally, the date of the note is the date on which
it is received by the Federal Reserve Bank, and the credit is passed on
the same day. The note is automatically charged to the bank's reserve
account on the maturity date. If the bank wishes to rebate the note,
in whole or in part, a letter or telephone call, subject to written
confirmation, is all that is necessary.


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Federal Reserve Bank of St. Louis

PROMISSORY NOTE-UNITED STATES AND AGENCY BONDS

#162

Illustration Q

Boston, Massachusetts
Location of Bank

$

2,000,000.00

February 2, 1910
Date

Seven (7)

days after date, for value received, the undersigned bank promises to pay to

the Federal Reserve Bank of Boston,or order, at the office of said Federal Reserve Bank in the City of Boston, Massachusetts,

Two Million and

no/100

Dollars, having deposited with and pledged to said Federal Reserve Bank, as collateral security for the payment of this note
and
any other liability or liabilities, whether direct or contingent, of the undersigned bank to the said Federal Reserve Bank, due
or to
become due or that may be hereafter contracted, the following obligations:

$ 100,000 U. S. Treasury Bills due April 22, 1970
100,000 U. S. Treasury Notes 8% due May 15, 1971
500,000 U. S. Treasury Bonds 4 1/0 due May 15, 1974
100,000 Federal Intermediate Credit Bank Debentures
200,000 Federal Home Loan Bank Bonds
100,000 Federal Land Bank Bonds
.
200,000 Federal National Morte;age Association Debentures
100,000 Export-Import Bank Notes 6 5/8% due September 19, 1971
200,000 Farmers Home Administration Notes 8 (/8%
due January 31, 1975
100,000 Farmers Home Administration Notes 8.90%
due January 31, 1980
100,000 Banks for Cooperatives 8.65% due August 3, 1970
200,000 Worcester Housing Authority Bond 5.25% due August 1, 1999

FROM:

Edward R. Rogers

To:

BE
BE
BE
SK
SK
SK

3125
3091
3011
349125
349872
349(2(

a 341746
SK 349137
SK 309127
SK 301171
SK 301875
SK 312485

E. J. McCarthy

The said Federal Reserve Bank Is also given a lien for the payment of this note and any of the said other liabilities upon all the
property or securities now or hereafter in the possession of said Federal Reserve Bank, which have been or may be received from or
for the account of the undersigned bank, including items in process of collection and the proceeds thereof, and also upon
any balance to the credit of the undersigned bank in its deposit account with the said Federal Reserve Bank, and it is hereby agreed by the
undersigned bank that the said Federal Reserve Bank has the right to require such additional security as it may deem proper, and,
on failure to respond forthwith to such requirement or on the nonpayment of this note, when due, or on the nonpayment of
any other
liability or liabilities, when due, of the undersigned bans, the said Federal Reserve Bank, or any holder hereof, is hereby given
full
authority to sell, assign and deliver, or collect the whole or any part of the above named collaterals, or any substitute
therefor, or
any addition thereto at any public or private sale or any brokers' board or stock exchange, at any time or times
hereafter, without
demand, advertisement or notice: and, upon such sale, the said Federal Reserve Bank or the holder hereof may become the
purchaser of the whole or any 'net of such collaterals, free from any right of redemption, and, after
deducting all legal or other costs and
expenses for collection, sale and delivery, may apply the residue of the proceeds of such collections, sale or sales
to the payment
of this note and of any, either or all of said other liabilities, as the said Federal Reserve Bank, or its assigns,
shall deem proper,
returning the overplus to the undersigned bank. The undersigned bank hereby authorizes and empowers said
Federal Reserve Bank,
at its option, at any time, to appropriate and apply to the payment of any or all of the liabilities of
the undersigned bank to the
Federal Reserve Bank, whether direct or contingent, or whether then due or to become due, or whether now existing
or hereafter
contracted, any money or balance now or hereafter in the hands of said Federal Reserve Bank, on deposit
or otherwise, to the credit
of or belonging to the undersigned bank. It is agreed that in the event
of the insolvency or bankruptcy of, or the appointment of a
receiver for, the undersigned bank, or in the event of its property and business being
taken possession of, or its business being
suspended by, or it being closed by, the lawfully authorized governmental agency or authority, this note
and all the said other liabilities and each of them shall immediately become due and payable, without demand or notice.
Name
of bank)

BD 15
Rev. (5-69 261)


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Federal Reserve Bank of St. Louis

Dollar National Bank

(11
"
c4
officer)

Executive Vice President

Methods of Adjustment...

McCARTHY

63

Frequently member banks borrow by telephone. In the case of a
so-called "dummy note" the bank calls and specifies amount, collateral and number of days. The officer telephoning must be one who
is authorized to borrow money in accordance with the borrowing
resolution on file at the Federal Reserve Bank. The bank immediately puts its note in the mail as confirmation of the telephone
request. The Federal Reserve Bank then credits the borrowing bank's
account on the day the telephone call is received by putting through
the "dummy note."
In addition to U.S. Treasury Bills, certificates of indebtedness,
Treasury Notes, and Treasury Bonds, the following agency obligations are now eligible as collateral for an advance at the discount
rate.
a. Federal Intermediate Credit Bank debentures.
b. Federal Home Loan Bank notes and bonds.
c. Federal Land Bank bonds.
d. Bank for Cooperative debentures.
e. Federal National Mortgage Association notes, debentures and
guaranteed certificates of participation.
f. Obligations of or fully guaranteed by the Government National
Mortgage Association.
g. Merchant Marine bonds.
h. Export-Import Bank notes and guaranteed participation certificates.
i. Farmers Home Administration insured notes.
j. Notes fully guaranteed as to principal and interest by the Small
Business Administration.
k. Federal Housing Administration debentures.
1. District of Columbia Armory Board bonds.
m.Tennessee Valley Authority bonds and notes.
n. Bonds and notes of local urban renewal or public housing
agencies fully supported as to principal and interest by the full
faith and credit of the United States pursuant to Section 302 of
the Housing Act of 1961 (42 U.S.C. 1421a(c), 1452(c)).
In addition to the above types of securities, a Federal Reserve
Bank may accept tax anticipation notes with a maturity not in excess
of six months from the date of the pledge. The Reserve Bank must
satisfy itself that sufficient tax or other assured revenues earmarked


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Federal Reserve Bank of St. Louis


https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis

TAX ANTICIPATION NOTE — Illustration R

ekoon.vg 1.0..‘'
z
, ,
o,.

,,i)
i,i ,
..,,, /
/1`,/ .r//7/
': .///17/;',/,/0
J 1//
7:47
17
9
/:

'7/1(:)/////
/
/////
/iii/
0
i//414)
,:

,

7,1/////
,i,/
/el//Ai'
• i4///
' i0,,,,.
'
•
_ 4- - 7'&ye_

1/
/7i/

ti
l

/,:id.
1
///t/tt///tV
fri
tta;ithie..V.///kfredee
,
,,.?/tI,/ftti
.7
/,i ,
iti.
/17/./twit///tz)..),,/
7.tottit/ti/
yr,://///,
t ;kit./
.llt).77,-///tPittti-...../(ttit
/ , Irritt,//t/ilitt
,/
,,i
. . /tar V
/% .
lAt'•__.
//2 -,
...//at'it.91
/(74
1;t14:tt;',.//7///i//t.'.) t/ittlit;yt it.//'it.
0 0 0
0 0
,.....,;.i..„....
,..,-....-..
/'
X)//-)/;/Mi.)._
ray

f?.

INTEREST ON THIS NOTE TO MATURITY

111+
"1
"7

•

Methods of Adjustment...

McCARTHY

65

for payment of such obligations will be available for that purpose at
maturity or within six months from the date of advance if no
maturity is stated.
Borrowings Secured by Eligible Paper
Eligible paper in general consists of notes, drafts, or bills of exchange which have been issued or drawn for a commercial or agricultural purpose and the proceeds of which have been used, or are to
be used
a. in producing, purchasing, carrying or marketing goods or
agricultural products in one or more of the steps of the
process of production, manufacture or distribution; or
b. in meeting current operating expenses of a commercial,
agricultural or industrial business; or
c. for the purpose of carrying or trading in direct obligations
of the United States.
To be eligible for rediscount or acceptable as collateral on
advances, notes of industrial and commercial borrowers must have a
maturity of not more than 90 days from the date of pledge or
discount, exclusive of days of grace. The Federal Reserve Board has
concluded that, since demand paper is due and payable on the date
of its issue, it satisfies the maturity requirements of the statute.
Therefore, demand paper which otherwise meets the eligibility requirements of the Federal Reserve Act and Regulation A is eligible
for discount and as security for advances by Reserve Banks. Agricultural paper must have a maturity of not more than nine months
from date of pledge or discount, exclusive of days of grace.
Paper is not eligible for discount if the proceeds have been used or
are to be used for permanent or fixed investments or for any fixed
capital purpose, or for financing transactions of a purely speculative
character or for carrying or trading in stocks, bonds, or other investment securities except direct obligations of the United States. Except
with the permission of the Board of Governors, no Federal Reserve
Bank may discount for a member bank any paper acquired from, or
bearing the signature or endorsement of a nonmember bank. However, the Federal Reserve Bank may discount such paper otherwise


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Federal Reserve Bank of St. Louis

ELIGIBLE PAPER NOTE — Illustration S
B.D. 3 8-59

Rockwell, Connecticut
Location of Bank

100,000.00

February 2, 1970
Date

Seven (7)

days after date, for value received, the undersigned bank
promises to pay to the Federal Reserve Bank of Boston, or order, at the office of said Federal Reserve Bank
in the City of Boston, Massachusetts,
One Hundred Thousand and

no/100

Dollars,

having deposited with and pledged to said Federal Reserve Bank, as collateral security for the payment of
this note and any other liability or liabilities, whether direct or contingent, of the undersigned bank to the
said Federal Reserve Bank, due or to become due or that may be hereafter contracted, notes, drafts, bills
of exchange, bankers' acceptances, and/or other security, as described in the schedule included in the
application for advance, dated February 2, 1970
accompanying and made a part hereof.
The said Federal Reserve Bank is also given a lien for the payment of this note and any of the said other
liabilities upon all the property or securities now or hereafter in the possession of said Federal Reserve
Bank, including items in process of collection and the proceeds thereof, and also upon any balance to the
credit of the undersigned bank in its deposit account with the said Federal Reserve Bank, and it is hereby
agreed by the undersigned bank that the said Federal Reserve Bank has the right to require such additional
security as it may deem proper, and, on failure to respond forthwith to such requirement or on the nonpayment of this note or on the nonpayment of any other liability or liabilities of the undersigned bank, the
said Federal Reserve Bank, or any holder hereof, is hereby given full authority to sell, assign and deliver,
or collect the whole or any part of the above named collaterals, or any substitute therefor, or any addition
thereto at any public or private sale or on any brokers' board or stock exchange, at any time or times hereafter, wtihout demand, advertisement or notice; and, upon such sale, the said Federal Reserve Bank or the
holder hereof may become the purchaser of the whole or any part of such collaterals, free from any right of
redemption, and, after deducting all legal or other costs and expenses for collection, sale and delivery, may
apply the residue of the proceeds of such collections, sale or sales for the payment of this note and of any, either
or all of said other liabilities, as the said Federal Reserve Bank, or its assigns, shall deem proper, returning the
over-plus to the undersigned bank. The undersigned bank hereby authorizes and empowers said Federal
Reserve Bank, at its option, at any time, to appropriate and apply to the payment of any or all of the
liabilities of the undersigned bank to the Federal Reserve Bank, whether direct or contingent, or whether then
due or to become due, or whether now existing or hereafter contracted, any money or balance now or hereafter
in the hands of said Federal Reserve Bank, on deposit or otherwise, to the credit of or belonging to the undersigned bank. It is agreed that in the event of the insolvency or bankruptcy of, or the appointment of a
receiver for, the undersigned bank, or in the event of its property and business being taken possession of,
or its business being suspended by, or it being closed by, the lawfully authorized government agency or
authority, this note and all the said other liabilities and each of them shall immediately become due and
payable, without demand or notice.


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Federal Reserve Bank of St. Louis

(Name
of bank)

City Trust Company
By
(Title of Executive
Vice President
officer)

ELIGIBLE PAPER APPLICATION — Illustration T
B. D..3 A

No

To Be Made In Duplicate

APPLICATION FOR ADVANCE

37

To the Federal Reserve Bank of Boston,
Boston, Massachusetts.

Date
TrustCo.

City

February 2

Rockwell, Connecticut

hereby make
Seven (7)
days_ secured
upon our promissory note for
by notes, drafts, bills of exchange or acceptances aggregating $ 101,500.00
which are listed in detail in the following
schedule.
You are hereby authorized to charge to our account at maturity this advance or to charge to our account at any time hereafter any of the paper listed below which you may deem ineligible or undesirable.
We, the

iNkkxt

application for an advance of $ 100,000

We hereby certify that, to the best of our knowledge and belief, the paper which is listed below is eligible as security for the
promissory note of this bank under Section 13 of the Federal Reserve Act and the Regulations of the Federal Reserve Board,
that none of the paper was acquired from non-member banks; and (if the applicant is a State bank or trust company) that
none of the borrowers liable on such paper is liable for borrowed money to the applying bank in an amount greater than that
which could be borrowed lawfully from the applying bank if it were a national bank.
On this date the total amount of money borrowed by this bank on bills payable, rediscounts or otherwise, not including
the advance covered by this application, is as follows:—
Federal Reserve Bank of Boston $

14(X
)
,"

-0-

; Elsewhere $

; Total $

1+00,000
Trust Company

City

/92.zatin
POST-OFFICE
ADDRESS
or
Place of Business

i
MAKER

'44'4 C

INDORSERS

_

9

Cacklex

AMOUNT DUE AT
MATURITY
(Principal plus
Interest if any)

MATURITY

Date of
Last
Statement
on File

10 McGreggor St.
Rockwell,
Connecticut

Leather
Fabric
Sportswear

20,000.00

3/12/70

2/31/69

Steel Co..-ny, Inc.
Robert Brown

5

Main Street
Rockwell
Connecticut

Steel

25,000.00

Demand

9/30/6;

9

Torrint .n Sand & Gravel Co.
None

2 Atlantic St.
Rockwell
Connecticut

Mfg. & Dist.

20,000.00

3/26/70

2/31/6S

9

Indepen
Corp.

10 South Street
Rockwell
Connecticut

Wholesale
Pipe Supplie

5,000.00

4/1/70

0/31/6(,

Brown Card Co., Inc.
None

8 Congress

St.
Rockwell
Connecticut

Greeting
Cards

12,000.00

Demand

6/30/6,

NationaJ Felt Company, Inc.
None

5 Broadway
Rockwell
Connecticut

Wholesale
Felt

10,000.00

4/10/70

6/30/6

Smith Leather Corporation
Robert Smith

2 Quincy St.
Rockwell
Connecticut

Mfg. Cut
Soles

9,500.00

4/22/70

9/30/6

City Sho

9 1/

Corporation
None

nt Pipe & Supply
None

9

B

BUSINESS
List business
of party
receiving
proceeds

iVt=s.
Executl

?

8 1/2


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Federal Reserve Bank of St. Louis

101,500.00

68

THE RESERVE POSITION

eligible for discount if the paper was bought on the open market or
otherwise acquired in good faith and not for the purpose of obtaining credit for a nonmember bank.
The procedure used in handling advances secured by eligible paper
is very similar to that of borrowing on government securities, other
than the processing of the collateral (eligible paper), which is much
more complicated.
Such borrowing is very time-consuming, both on the part of the
member bank and on the part of the Federal Reserve Bank. Both the
borrower and the Federal Reserve Bank must determine if the collateral meets the eligibility test as set forth by the Federal Reserve
Act and Regulation A of the Board of Governors of the Federal
Reserve System.
The Federal Reserve Bank of Boston requires the borrower to file
an application in duplicate, setting forth the maker of the note, the
endorser, place of business, type of business, amount due at
maturity, and maturity date on each piece of paper offered as collateral. Each note must be endorsed by the member bank (an allonge
is acceptable) and physically shipped to the Federal Reserve Bank,
together with a copy of a recent balance sheet and operating statements on all notes of $5,000 or more.
The member bank must then substitute in its file a record in lieu
of the actual notes. It has been reported that some banks make a
photostatic copy of each note that is forwarded to the Federal
Reserve Bank. An additional reason for not borrowing on eligible
paper is that it has become apparent to the customer that his bank
has borrowed on his note. Banks don't like to have their customers
know that they occasionally have to borrow. Federal Reserve Banks
stand ready to make an advance on eligible paper when such an
advance appears necessary. This type of accommodation has increased markedly since 1963.


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Methods of Adjustment...

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69

Rediscounts of Eligible Paper
The procedure in rediscounting eligible paper is similar to that in
borrowing on advances secured by eligible paper. Both the Reserve
Banks and the member banks find that rediscounting is less convenient than borrowing on their own note secured by eligible paper.
The important difference is that an advance may be made in the
exact amount and maturity needed, and the Reserve Bank generally
extends short-term credit not in excess of seven days. It is difficult
for a bank to select eligible paper of precisely the right amounts and
maturities to offer as rediscounts.
It is much simpler for the Federal Reserve Bank to handle an
advance for seven days secured by eligible paper than to rediscount
many notes, for the obvious reason that fewer calculations are required. There is less bookkeeping and filing in handling one note
than in dealing with several records for each individual note. It has
become our policy in recent years to request our member banks to
borrow on their own seven-day note and secure it with eligible paper
rather than rediscounting their customers notes. As indicated in the
illustration, we have not rediscounted any eligible paper since March
1960.
Borrowings Under Section 10(b)
Another method of borrowing that is not familar to many of the
banks is under the authority of Section 10(b) of the Federal Reserve
Act. Advances under this section may be granted on any satisfactory
collateral. Such advances are required by law to carry a rate of 1/2 of
1 percent in excess of borrowings secured by eligible paper or U.S.
Government securities. The procedure for borrowing under these
provisions is very similar to advances on eligible paper or government
securities. The borrower must forward his note, together with an
application listing the collateral to be pledged.
The borrowings at the Federal Reserve Bank of Boston made
under this provision have been secured by municipal bonds. In each
instance to date, the collateral to be pledged was held in safekeeping
and merely required the endorsement of the borrower with instructions to collateralize the loan. It is also possible for a member bank
which holds its collateral at a correspondent bank to make arrangements to deliver a trust receipt to the Federal Reserve Bank of


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Federal Reserve Bank of St. Louis

SECTION 10(b) — Illustration U
NOTE
Milton, Maine
Location of Bank

1,000,000.00

February 2, 1970
Date

Seven (7)
days after date, for value received, the undersigned bank
promises to pay to the Federal Reserve Bank of Boston, or order, at the office of said Federal Reserve
Bank in the City of Boston, Massachusetts,
One Million and

no/100

Dollars,
having deposited with and pledged to said Federal Reserve Bank, as collateral security for the payment
of this note and any other liability or liabilities, whether direct or contingent, of the undersigned bank to
the said Federal Reserve Bank, due or to become due or that may be hereafter contracted, notes, drafts,
bills of exchange, bankers' acceptances, or other security, as described in the schedule included in the
application for advance, dated February 2, 1970
accompanying and made a part
hereof. The said Federal Reserve Bank is also hereby given a lien for the payment of this note and any of
the said other liabilities upon all the property or securities now or hereafter in the possession of said Federal
Reserve Bank, including items in process of collection and the proceeds thereof, and also upon any balance
to the credit of the undersigned bank in its deposit account with the said Federal Reserve Bank, and it is
hereby agreed by the undersigned bank that the said Federal Reserve Bank has the right to require such
additional security as it may deem proper, and, on failure to respond forthwith to such requirement or on
the nonpayment when due of this note or on the nonpayment when due of any other liability or liabilities
of the undersigned bank, the said Federal Reserve Bank, or any holder hereof, is hereby given full authority
to sell, assign and deliver, or collect the whole or any part of the above named collaterals, or any substitute therefor, or any addition thereto at any public or private sale or on any brokers' board or stock
exchange, at any time or times hereafter, without demand, advertisement or notice; and, upon such sale,
the said Federal Reserve Bank or the holder hereof may become the purchaser of the whole or any part
of such collaterals, free from any right of redemption, and, after deducting all legal or other costs and
expenses for collection, sale and delivery, may apply the residue of the proceeds of such collections, sale
or sales to the payment of this note and of any, either or all of said other liabilities, as the said Federal
Reserve Bank, or its assigns, shall deem proper, returning the over-plus to the undersigned bank. The
undersigned bank hereby authorizes and empowers said Federal Reserve Bank, at its option, at any time,
to appropriate and apply to the payment of any or all of the liabilities of the undersigned bank to the
Federal Reserve Bank, whether direct or contingent, or whether then due or to become due, or whether
now existing or hereafter contracted, any money or balance now or hereafter in the hands of said Federal
Reserve Bank, on deposit or otherwise, to the credit of or belonging to the undersigned bank. It is agreed
that in the event of the insolvency or bankruptcy or failure of, or the appointment of a conservator or
liquidating agent or receiver for, the undersigned bank, or in the event of the undersigned being closed or
suspended by its board of directors or, its property and business being taken possession of, or its business
being suspended by, or it being closed by, the lawfully authorized governmental agency or authority, this
note and all the said other liabilities and each of them shall immediately become due and payable, without
demand or notice.

(Name
of bank)

Lake National Bank

By
(Title of
officer)
B.D. 97(A)


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Federal Reserve Bank of St. Louis

Executive Vice President

APPLICATION SECTION 10(b) — Illustration V
B.D. 97 t 1-62 531()

(To be made in duplicate)
No.

37
APPLICATION FOR ADVANCE
UNDER SECTION 10 (b) OF THE FEDERAL RESERVE ACT AS AMENDED
February 2

Date

1970

To the Federal Reserve Bank of Boston,
Boston, Massachusetts.
Lake National Bank
The undersigned bank,
, hereby makes
.
application for an advance of $ . 1,000 0,
upon its promissory note on form B.D. 97(A) maturing
Seven (7)
days from the date of such advance secured by the bonds, notes, drafts, bills of exchange,
200,000.
acceptances or other security, aggregating $ 1,200,000.
in face amount, which are hereinafter listed in detail
in Schedule A below.
The undersigned bank hereby certifies that the security offered to this advance has not been acquired from a nonmember bank otherwise than in accordance with Section 5 of Regulation A; and that except as otherwise noted in Schedule A the undersigned has on file a statement which adequately reflects the financial worth of a party primarily liable on
the paper offered as security for this advance.
You are hereby authorized to charge this advance to the account of the undersigned at any time hereafter if a demand
note, or at maturity if a time note, or to charge to the account of the undersigned the loan value as determined by you of
any of the collateral now or hereafter securing this advance which you may deem unsatisfactory or undesirable.
On this date, the total amount of money borrowed by this bank on bills payable, rediscounts or otherwise, not including the advance covered by this application, is as follows:
Federal Reserve Bank of Boston-4

2/"10°°•

Elsewhere—$.
(Name
of bank)

500,000,

Total—$

2,500,000.

Lake National Bank

By
(Title
officer)°fExecutive Vice President
(Must be signed by an officer authorized by resolution flied
with the Federal Reserve Bank,

Schedule A
This Space for F. R. Bank only
Description

APPRAISAL

Face Amount
Price

Market
Value

Loan
Value

Ruing

Mass. Turnpike Authority
(Sumner Tunnel)
4 3/4% due April 1, 1999

300,000.

73

219,000.

BAA

Maine Turnpike Authority
(Revenue)
4% due January 1, 1989

300,000.

76

228,000.

A

Comm. (Expressway G. 0.)
3 1/4% due January 1, 1976

200,000.

75

150,000.

AAA

Rhode Island Turnpike & Bridge
Authority
4.90% due December 1, 2016

1400,000,

67

268,000.

A


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Federal Reserve Bank of St. Louis

1,200,000.

ILLUSTRATION V

865,000.

THE RESERVE POSITION

72

Boston. On the day of the advance, the borrowing bank would
indicate to its correspondent by telephone a complete description of
the securities to be pledged. The correspondent would then advise
the Federal Reserve Bank of Boston by telephone, subject to a confirming telegram.
Presumably, a member bank would prefer not to borrow on this
type of loan if it owned government securities which were available
as collateral. But if a member bank had exhausted its government
securities, it probably would be willing to pay the penalty rate to
avoid the detail of rediscounting or pledging eligible paper. It is
assumed that the Federal Reserve Bank of Boston would not deny
the member bank this privilege.
As indicated above, each application must be accompanied by a
promissory note. The application form, among other things, provides
for the following:
a. amount of money borrowed by applicant at Federal
Reserve Bank and elsewhere;
b. authorization of the Federal Reserve Bank to charge the
amount of the advance to the account of the borrowing
bank any time after the date of the advance if written on
demand or at maturity if written on time;
c. description and face amount of collateral offered to secure
the advance.
The present policy at the Federal Reserve Bank of Boston is to
permit a loan value of par for municipal securities.
The Federal Reserve Bank of Boston has been able to pass credit
to the borrower on the same day as the application was received, as
all of its loans of this type have been secured by high-grade, readilymarketable bonds.
At the present time the basic law and Regulation A,issued by the
Board of Governors of the Federal Reserve System, are being
reviewed with the objective of increasing the flexibility of Federal
Reserve Bank lending arrangements.


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Federal Reserve Bank of St. Louis

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73

The major changes proposed in the Regulation are with reference
to collateral securing borrowing from the Federal Reserve Banks. As
indicated above, the Act provides for loans to member banks for
appropriate purposes secured by U.S. Government obligations or by
eligible paper which may be made at the discount rates in effect at
the various Reserve Banks. The current changes in the law, if approved by the Congress, will eliminate the technical requirements
regarding eligible paper from the Federal Reserve Act.
The revision contemplates that, subject to the Board's regulations,
member bank borrowing from a Federal Reserve Bank need simply
be secured by assets satisfactory to the Federal Reserve Bank, and all
such borrowings will be at the discount rate.
Proposed Revision of Discount Window Administration
On July 15, 1968, the Federal Reserve published a System report
entitled, "Reappraisal of the Federal Reserve Discount Mechanism,"
the result of an intensive three-year study of Federal Reserve lending
policies. While the report reaffirms the three long-established principles of Federal Reserve lending policy, it proposes several
significant changes in lending policies and procedures aimed at providing more liberal and clear-cut access to the discount window. If
these proposals are adopted, the discount window may play a more
active part in enabling commercial banks to meet their communities'
credit needs more effectively.
To provide more clear-cut access to the discount window, the
report proposes that each soundly-operated member bank have a
"basic borrowing privilege," enabling it to automatically borrow
limited amounts of funds from its Reserve Bank for a specified
number of weekly reserve periods.
The report further provides for seasonal credit accommodation for
member banks with large seasonal swings in excess of a specified
minimum.
Member banks would not be limited to borrowing under the terms
of these proposals, but additional borrowing would be subject to
essentially the same administrative policy and procedure now applied
to member banks.


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Federal Reserve Bank of St. Louis

74

THE RESERVE POSITION

A final major new idea proposed by the report is to make the
discount rate more flexible than in the past. The report recommends
that the discount rate be changed more frequently to keep it closely
in line with movements in other money market rates.
A copy of the report may be obtained by writing the Federal
Reserve Bank of Boston, Public Information Department.
COMMENTS AND CONCLUSIONS
This study has attempted to better acquaint bankers with the
procedures of "money market instruments" and to show how excess
reserves may be employed most effectively.
Most large banks assign one of their officers, generally a vice
president, the responsibility of maintaining the reserve position. His
desk is generally referred to as the "money desk." One of the
principal responsibilities of the man at the money desk is the establishment of a system throughout his bank whereby all significant
transactions that affect the money position are reported to him
immediately. Such transactions would include large transfers into or
out of customers' accounts, large purchases or sales of securities for
account of customers or in or out of the bank's portfolio, transfers in
or out of the Treasury Tax and Loan account or sizeable new loans,
or maturities and rebates of outstanding loans. All of these factors
are of vital interest to the money desk, as they constitute the
principal data used to gauge the reserve position of the member
bank.
There is no practical need for member banks to carry with the
Federal Reserve Bank more than the prescribed requirements. On
occasion, when reserve balances at the Federal Reserve increase to
amounts in excess of requirements and in excess of current needs,
such funds can be profitably employed in very short-term investments or sold to a bank that needs them. Since reserve requirements
are averaged over a seven-day period, there is no legal need to keep
more than the amount necessary to average out over the period. The
Federal Reserve Banks have no interest in excess balances above
those required by the regulation.
As indicated above, the fastest and most convenient method of
employing or acquiring funds is through ,the Federal Funds market.


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Federal Reserve Bank of St. Louis

Methods of Adjustment...

McCARTHY

75

However, it must be borne in mind that there will be occasions when
funds are not offered or available, and likewise when no institution is
seeking to buy funds.
Assuming a bank has difficulty in adjusting its position through
the Federal Funds market, the next most popular method is the
Treasury Bill market. Because of the widespread use (since 1948) of
Federal Reserve wire facilities in the purchase and sale of government
securities, with its advantages of payment in immediately available
Federal Funds, the dealers and banks insist upon making trades payable in Federal Funds. A bank may buy or sell Treasury Bills and
receive credit for the sale, or pay for and commence accuring
earnings on the same day the trade is made. Treasury Bills are called
"near money" for the above reasons.
The hypothetical case cited strongly indicates that the person
assigned to the bank's money position is not employing the excess
reserves. For the seven-day reserve period ended January 7, 1970, his
bank on a daily basis averaged $105,400 in excess of requirements. If
the above funds were employed, either in Federal Funds or Treasury
Bills, and the rate of return was 8 percent, it would have resulted in
earnings of $163.96, or approximately $8,525.92 if the excess were
continued for a full year. The bank under discussion is a relatively
small bank with total deposits of about $30 million.
In conclusion then, it appears reasonable to suggest that those
bankers who are not now familiar with money market instruments
would do well to review their use in connection with efficient
management of their money position, with a view to employing
safely all excess funds in order to maximize earnings.


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Federal Reserve Bank of St. Louis

76

THE RESERVE POSITION

BIBLIOGRAPHY
Books
Greef, Albert 0. The Commercial Paper House in the United States,
Harvard University Press, Cambridge, Massachusetts
McKinney, George. The Federal Reserve Discount Window, Rutgers
University Press, New Brunswick, New Jersey
Pamphlets
Federal Reserve Bank of Boston. Purchase and Sale of U.S.
Government Securities, Operating Letter No. 12, November 1961
Federal Reserve Bank of Chicago. Modern Money Mechanics, May
1961
Fieldhouse, Richard. Certificates of Deposit, Bankers Publishing Co.,
Boston, Massachusetts
First Boston Corporation, Boston. Securities of the United States,
June 1962
Madden, Carl H. The Money Side of "the Street", Federal Reserve
Bank of New York
Salomon Bros. & Hutzler, Wall Street, New York. Short-Term
Investments, Fourth Edition, March 1961
Willis, Parker B. The Federal Funds Market, Federal Reserve Bank of
Boston, 1957


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Federal Reserve Bank of St. Louis

McCARTHY

Methods of Adjustment...

77

Regulations
Board of Governors of the Federal Reserve System. Federal Reserve
Act, as Amended
Board of Governors of the Federal Reserve System. Regulation A,
Advances and Discounts
Board of Governors of the Federal Reserve System. Regulation C,
Bankers'Acceptances
Board of Governors of the Federal Reserve System. Regulation D,
Required Reserves
Records
Federal Reserve Bank of Boston. Discount Division
Periodicals and Newspapers
American Banker, December 21, 1962
Banking Journal of the American Bankers Association,
September 1959
Monthly Review,June 1961, Federal Reserve Bank of New York
New York Times, August 16, 1963
Interviews
Richard A. Hall, Vice President, The First National Bank of Boston
Harold Mayer, Vice President, Government Bond Department, First
Boston Corporation
Loring C. Nye, Assistant Vice President, Federal Reserve Bank of
Boston
Parker B. Willis, Vice President, Federal Reserve Bank of Boston


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Federal Reserve Bank of St. Louis

Copies of this Publication
are available, upon request, from the
PUBLIC INFORMATION CENTER
FEDERAL RESERVE BANK OF BOSTON
BOSTON,MASSACHUSETTS 02196


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Federal Reserve Bank of St. Louis