The effective annual interest rate on a loan in which a company borrows $1000,000 for one year at 8 percent and requires a compensating balance of 10 percent is:

Question

Quizplus · Accepted Answer

Compensating balance is the amount a borrower must keep on deposit in a bank to offset the cost the bank incurs in making the loan, therefore the amount that the borrower actually receives is reduced. In this case, the borrower receives $900,000 ($1,000,000 - 10%) but must pay interest on the entire $1,000,000. The effective annual interest rate can be calculated as follows: 
Effective annual interest rate = (Interest paid / Amount borrowed) x (365 / Days loan outstanding) x 100%
= ($80,000 / $900,000) x (365 / 365) x 100%
= 8.9%
Therefore, the best choice is C, 8.9%.

The Effective Annual Interest Rate on a Loan in Which