Would it be worth it to incur a compensating balance of $2,000 in order to get a 1.5-percent-lower interest rate on a 1-year,pure discount loan of $100,000? A)Yes B)No C)Not enough information is given to determine It depends upon whether $100,000 × (1 + i) or $102,000 × (1 + [i - 0.015]) is larger.The compensating balance for the lower loan rate will make sense if: $100,000 × (1 + i) $102,000 × (1 + [i - 0.015]) ($100,000/$102,000) × (1 + i) (1 + [i - 0.015]) 0)9804 + 0.9804i 1 + i - 0.015 -0)0196i 0.0046 I

Question

Would it be worth it to incur a compensating balance of $2,000 in order to get a 1.5-percent-lower interest rate on a 1-year,pure discount loan of $100,000?
A)Yes
B)No
C)Not enough information is given to determine It depends upon whether $100,000 × (1 + i) or $102,000 × (1 + [i - 0.015]) is larger.The compensating balance for the lower loan rate will make sense if:
$100,000 × (1 + i) > $102,000 × (1 + [i - 0.015])
($100,000/$102,000) × (1 + i) > (1 + [i - 0.015])
0)9804 + 0.9804i > 1 + i - 0.015
-0)0196i > 0.0046
I < -0.234694
In other words, only if the rate is less than -23.47 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 -23.47% for the compensating balance to make sense in getting a lower interest rate. Since this is highly unlikely to happen, it is not worth incurring a compensating balance of $2,000 to get a 1.5% lower interest rate on the pure discount loan of $100,000. Therefore, the best choice is B.

Would It Be Worth It to Incur a Compensating Balance