A firm borrows $200,000 from the bank, but has to maintain a compensating balance of $15,000 with the bank.The annual interest rate for the loan is 13%.What is the effective annual rate if the interest is compounded annually?

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) is calculated by considering the actual amount available for use after maintaining the compensating balance. The firm effectively borrows $185,000 ($200,000 - $15,000). The interest paid is $26,000 (13% of $200,000). The EAR is calculated as ($26,000 / $185,000) * 100% = 14.05%.

A Firm Borrows $200,000 from the Bank, but Has to Maintain