A bank lends a firm $1,000,000 for one year at 12 percent on a discounted basis and requirescompensating balances of 10 percent of the face value of the loan. The effective annual interest rateassociated with this loan is

Question

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The loan is discounted, meaning the interest is deducted upfront. The firm receives $880,000 ($1,000,000 - $120,000 interest - $100,000 compensating balance). The effective interest rate is $120,000/$880,000 = 13.64%, rounded to 15.4% when considering the compensating balance.

A Bank Lends a Firm $1,000,000 for One Year at 12