Final answer:
A financially healthy bank that borrows overnight from the Federal Reserve is engaging in what is known as primary credit. The correct answer is option 3 .
Step-by-step explanation:
A financially healthy bank borrowing overnight from the Federal Reserve is known as primary credit. The Federal Reserve's discount window provides three credit options to depository institutions: primary credit, secondary credit, and seasonal credit. Among these, primary credit is offered to depository institutions that are in a sound financial condition for short-term needs, usually overnight. The interest rate charged on this borrowing is known as the discount rate, which is usually set above the short-term market interest rates to encourage banks to seek funds from alternative sources before turning to the Federal Reserve.
The rate for secondary credit is typically higher than that for primary credit and is available to institutions that are not eligible for primary credit. Seasonal credit is aimed at smaller institutions that experience fluctuating cash flow needs throughout the year. Yet, primary credit is the most relevant for healthy banks looking for quick liquidity.
In the current financial system, the Federal Reserve encourages banks to use other funding sources before using the discount window by setting the discount rate higher than the federal funds rate. Such loans are fully secured and are relatively rare in modern banking due to the preference for open market operations as a tool for executing monetary policy. Therefore, the Federal Reserve provides these loans primarily as a backup rather than a regular banking operation.
The correct option for a financially healthy bank borrowing overnight from the Federal Reserve is 3) primary credit.