You are getting a discount loan of $150,000 for one year. The stated rate of interest is 7.5% and there is a required 20% compensating balance. Calculate the effective interest rate.

Question

Quizplus · Accepted Answer

The effective interest rate can be calculated by considering the compensating balance requirement. With a 20% compensating balance, you effectively have access to only 80% of the $150,000, which is $120,000. However, you're still paying interest on the full $150,000. The interest paid is 7.5% of $150,000, which is $11,250. The effective interest rate is then $11,250 divided by the actual amount received ($120,000), which equals 9.375% or rounded to 9.38%, not 10.34%. The correct calculation leads to D) 9.38%, indicating an error in the initial selection.

You Are Getting a Discount Loan of $150,000 for One