The effective interest rate
A) is lower if the loan is a discount loan.
B) is higher on a loan if interest is paid at maturity.
C) is not affected by whether the loan is a discount loan or a loan with interest paid at maturity.
D) is higher if the loan is a discount loan.

Question

Quizplus · Accepted Answer

The effective interest rate takes into account the time value of money and all fees associated with the loan. In case of a discount loan, the interest is deducted upfront from the loan amount, which means the borrower receives less money and pays more interest; hence, the effective interest rate is higher. On the other hand, if interest is paid at maturity, the borrower receives the full loan amount upfront and pays interest at maturity, resulting in a lower effective interest rate. Therefore, the effective interest rate is higher on a discount loan, and so option D is the correct choice.

The Effective Interest Rate