Final answer:
Banks that borrow from the Federal Reserve under secondary credit pay an interest rate equal to the discount rate plus a penalty. This rate is higher than the primary credit rate to reflect additional risk. The federal funds rate is unrelated as it is the rate banks charge each other for overnight loans.
Step-by-step explanation:
Banks experiencing financial difficulties may borrow from the Federal Reserve under a lending program known as secondary credit. When a bank borrows under the secondary credit program, it pays an interest rate that is set above the primary credit rate. Specifically, banks borrowing secondary credit will pay an interest rate equal to the discount rate plus a penalty. This higher rate compared to the primary credit rate reflects the greater level of risk the Fed assumes when lending to institutions under financial stress.
The discount rate itself is the interest rate charged by the Federal Reserve to commercial banks and other depository institutions on loans they receive through the Federal Reserve's discount window. The Fed offers three different discount window programs—primary credit, secondary credit, and seasonal credit—each with its own interest rate, where secondary credit is priced higher than primary credit.
The interest rate that banks charge each other for overnight loans is known as the federal funds rate. While the discount rate for secondary credit is higher than the primary credit rate, it is not directly tied to the federal funds rate.