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Homework answers / question archive / A XYZ bank lends a firm $5,000,000 for one year at 12 percent on a discounted basis and requires compensating balances of 10 percent of the face value of the loan
A XYZ bank lends a firm $5,000,000 for one year at 12 percent on a discounted basis and requires compensating balances of 10 percent of the face value of the loan. The effective annual interest rate associated with this loan is __________.
A. 6.67 %
B. 7.69%
C. 6.41%
Answer )
Please Note that
Discounted loans are loans that have the interest payment subtracted from the principal before the loan is disbursed .
Also in some loans you may be required to keep a deposit of funds at the bank to qualify for the loan. This deposit is known as a compensating balance and If you fail to repay the loan, the bank can seize the compensating balance.
So For Calculating effective annual interest rate We have to Divide interest by the available principal
Interest Paid = $5,000,000 * 12% = $6Lakh
Compensating Balance Kept by bank = $5,000,000 * 10% = $500000
Amount Received (i.e. Principal Available) = $5,000,000 - $600000 - $500000 = $3900000
Amount Received = $39 Lakh
Effective Interest Rate = $6 Lakh / $3900000
= 15.38%
