Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percent-lower interest rate on a 1-year,pure discount loan of $500,000? A)Yes B)No C)Not enough information is given to know It depends upon whether $500,000 × (1 + i) or $510,000 × (1 + [i - 0.01]) is larger.The compensating balance for the lower loan rate will make sense if: $500,000 × (1 + i) $510,000 × (1 + [i - 0.01]) ($500,000/$510,000) × (1 + i) (1 + [i - 0.01]) 0)9804 + 0.9804i 1 + i - 0.01 -0)0196i 0.0096 I

Question

Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percent-lower interest rate on a 1-year,pure discount loan of $500,000?
A)Yes
B)No
C)Not enough information is given to know It depends upon whether $500,000 × (1 + i) or $510,000 × (1 + [i - 0.01]) is larger.The compensating balance for the lower loan rate will make sense if:
$500,000 × (1 + i) > $510,000 × (1 + [i - 0.01])
($500,000/$510,000) × (1 + i) > (1 + [i - 0.01])
0)9804 + 0.9804i > 1 + i - 0.01
-0)0196i > 0.0096
I < -0.4697959
In other words, only if the rate is less than -46.98 percent.Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

Quizplus · Accepted Answer

The calculation shows that the interest rate would have to be less than -46.98% for the compensating balance to make sense. Since this is highly unlikely to happen, it is not worth paying a compensating balance of $10,000 to get a 1% lower interest rate on a 1-year, pure discount loan of $500,000. Therefore, the best choice is option B.

Would It Be Worth It to Incur a Compensating Balance