"This morning's move by the Fed is largely symbolic and suggests the Fed is willing to act in the event conditions in the financial markets deteriorate further, but we're far from being out of the woods," said Mike Malone, trading analyst at Cowen & Co.
The Dow Jones Industrial Average ended up 233.3 points, or 1.82%, to 13,079.1, giving it a weekly loss of 1.2%.
Of the Dow's 30 stocks, 25 closed ahead, led by Exxon Mobil Corp. , which was up 4.3% amid a rise in the price of oil.
Bank stocks, hit hard by the relentless credit market upheaval, were also among the Dow's larger gainers, with JP Morgan Chase Co. ahead 3.4% and Citicorp Inc. up 2.7%.
DuPont & Co. Inc. was among the few Dow stocks losing ground, with its stock off 1.4%. General Motors Corp. and McDonald's Corp. also edged lower.
The S&P 500 index was up 34.67 points, or 2.5%, at 1,445.94, with the S&P losing 0.5% for the week.
The Nasdaq Composite climbed 53.96 points, or 2.2%, to 2,505.03, with the Nasdaq falling 1.5% for the week.
Volume at the New York Stock Exchange topped 2.5 billion shares, with advancing stocks beating decliners 3 to 1. At the Nasdaq, 2.6 billion shares were exchanged, with gainers beating decliners, also by 3 to 1.
Shares of embattled Countrywide Financial Corp. climbed 13.1% after the nation's largest mortgage lender was upgraded to neutral from sell by Banc of America Securities.
Hewlett-Packard Co. advanced 2.4% after the tech giant posted a 29% jump in third-quarter profits.
Shares of Nordstrom Inc. gained 1.9% after trading lower for much of the day after noting in its second-quarter results that it had upped its reserve on bad credit by about $22 million from a year earlier.
Ahead of the opening, the Federal Reserve said it had cut the discount rate to 5.75%, while acknowledging the precarious state of credit markets in making the move.
"The Fed move was to bolster confidence; it's to kick start trading in the stock market and has no meaningful mechanical action on the commercial paper market," said Michael Englund, principal director and chief economist for Action Economics LLC.
"The decision by the Fed is an important one, and very positive, but significant risks still exist," said Malone. "Asia was down significantly overnight, so clearly negative sentiment was accelerating" before the Fed made its move, said Malone.
"The Fed's move was a very positive surprise," said Owen Fitzpatrick, head of the U.S. equity group at Deutsche Bank. "People will now probably place a high probability of a cut [in the Fed funds rate] in September."
"It's a band aid but we still need to get to a point where credit markets are functioning properly," said Fitzpatrick.
Ahead of the Fed announcement, stock futures were trading broadly lower after the worst session in seven years from Japan's Nikkei 225.
"The Fed cutting the discount rate is probably what the markets need to get normality back in place and reverse this crisis of confidence we're having in the marketplace," said Peter Cardillo, chief economist at Avalon Partners.
U.S. stocks experienced a dramatic reversal in the final hour of trade Thursday, helping the Dow industrials recoup much of a 340-point deficit to finish only slightly lower.
U.S. consumer sentiment declined in mid-August, according to a survey by the University of Michigan and Reuters. The consumer sentiment index fell to 83.3 from 90.4 in June, well below the 88.0 reading expected by economists polled by MarketWatch.
Crude-oil and other energy futures rallied Friday, boosted by concerns Hurricane Dean might hinder oil-production in the Gulf of exico. Crude for September delivery rose 98 cents to close at $71.98 a barrel on the New York Mercantile Exchange.
Gold futures rose sharply, recovering from steep losses Thursday, after the Fed's announcement. Gold for December delivery rallied $8.80 to close at $666.80 an ounce on the New York Mercantile Exchange. However, the contract lost $14.80 on the week.
Treasury prices closed slightly lower. The benchmark 10-year note was down 2/32 at 100 21/32, with a yield of 4.677%.
The yen fell below multi-month highs against the dollar as the stock market rally instilled a bit of confidence in the U.S. currency. The dollar rose 0.2% to 114.054 yen, after overnight drooping to a 14-month low of 115.57. The euro gained 0.6% at $1.3504 and the pound was down 0.02% at $1.9828.
By Kate Gibson