Banks leaped at the Fed's auction, which was held on Monday, with 93 bidders submitting US$61.6 billion in bids.
Analysts had expected the interest rate to be somewhere between the overnight federal funds rate of 4.25 per cent and the discount rate of 4.75 per cent.
The Fed auctioned off the money as part of a coordinated move by central banks around the globe to thaw frozen credit markets.
Demand for the funds and how much banks were willing to pay offered a signal of how deep financial distress is and how important a role the Fed and other central banks can play in easing the strains.
In the financial markets, U.S. stocks advanced, with shares of financial companies gaining. Prices for most U.S. Treasury securities slipped, pushing yields higher, though short-term yields on government debt eased.
The chances of a January interest-rate cut from the Fed, as implied by prices on interest-rate futures contracts, moved down to 76 per cent from 84 per cent before the results were announced.
Earlier on Wednesday, the second-largest U.S. investment bank, Morgan Stanley, posted a huge fourth-quarter loss after recording a bigger-than-expected US$9.4 billion write-down.
Credit crisis
As a rising tide of U.S. mortgage delinquencies sparked a global credit crisis this summer, interbank borrowing costs jumped to unusually high levels when compared with the Fed's target for overnight lending.
A key barometer of the success or failure of the Fed auction and related steps by other central banks will be the reaction of the benchmark three-month London Interbank Offered Rate, or Libor.
Most money market rates have come down since the central banks announced special liquidity measures last week.
The Fed and other major central banks, including the European Central Bank, announced an unusual coordinated action on December 12 to make short-term cash available to banks that were having trouble raising money for their operations.
As part of the coordinated actions announced by central bank last week, the Fed will conduct a second auction today for up to US$20 billion.
- Reuters