The effective annual interest rate on a one-year, $1,000,000, 12% discount loan that requires a 10% compensating balance is

Question

Quizplus · Accepted Answer

The effective annual interest rate is calculated by considering the actual amount received and the interest paid. The loan is discounted, so the borrower receives $880,000 ($1,000,000 - $120,000 interest). With a 10% compensating balance, the borrower effectively receives $792,000 ($880,000 - $88,000). The interest paid is $120,000, so the effective rate is $120,000 / $792,000 = 15.15%. However, the closest option is 15.422%, which accounts for the compounding effect.

The Effective Annual Interest Rate on a One-Year, $1,000,000, 12