Question

The Lodge borrowed $2,000,000 for five years at an annual interest rate of 9% from the Merchant Bank, which required a $100,000 compensating balance. What was the effective interest rate for the loan?(rounded to the nearest tenth of one percent)

a) 9.0%
b)9.5%
c)10.0%
d)10.5%

Answer 1

option (b) 9.5%

Step-by-step explanation:

Data provided in the question:

Loan Amount = $2,000,000

Annual interest rate = 9%

Required compensating balance = $100,000

Now,

Effective interest rate(EIR)

= (loan × Annual interest on loan) ÷ (Loan - Required compensating balance)

= ($2,000,000 × 9% ) ÷ ( $2,000,000 - $100,000 )

= ($2,000,000 × 0.09 ) ÷ ( $1,900,000 )

= 0.0947 ≈ 0.095

or

= 0.095 × 100%

= 9.5%

Hence,

the answer is option (b) 9.5%