Rachel's has a $45,000 line of credit with an interest rate of 7.4 percent and a compensating balance requirement of 2.75 percent. The compensating balance is based on the total amount borrowed with funds being held in an interest-free account. What is the effective annual interest rate if the company requires $28,000 of borrowed funds for one year?

Question

Quizplus · Accepted Answer

The effective annual interest rate accounts for the compensating balance requirement. The compensating balance is 2.75% of $28,000, which is $770. The actual amount available for use is $28,000 - $770 = $27,230. The interest paid is 7.4% of $28,000, which is $2,072. The effective rate is $2,072 / $27,230 = 7.61%.

Rachel's Has a $45,000 Line of Credit with an Interest