If you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent,but interest is prepaid (a discounted loan),then what is your effective annual rate?
A) 14.00%
B) 8.57%
C) 16.28%
D) 21.21%
E) 28.00%

Question

Quizplus · Accepted Answer

With a discounted loan, the interest is deducted from the principal at the beginning of the loan period. Therefore, if you borrow $2,000 at a 14% interest rate, the interest amount is $2,000 * 14% = $280. This means you actually receive $2,000 - $280 = $1,720 upfront. However, you still have to pay back the full $2,000 at the end of the year. The effective annual rate (EAR) is calculated as the interest paid divided by the actual loan amount received, then multiplied by 100 to get a percentage. So, EAR = ($280 / $1,720) * 100 = 16.28%.

If You Borrow $2,000 from a Bank for One Year