The effective annual interest rate on a one-year, $1,000,000, 10% discount loan that requires a 10% compensating balance is

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The effective annual interest rate on a one-year, $1,000,000, 10% discount loan that requires a 10% compensating balance is 11.1%. This is because the bank is effectively lending the borrower only $900,000, since the borrower must maintain a 10% compensating balance. The interest rate on the loan is 10%, so the effective annual interest rate is 10% / 0.9 = 11.1%.

The Effective Annual Interest Rate on a One-Year, $1,000,000, 10