Question

Summit Record Company is negotiating with two banks for a $151,000 loan. Fidelity Bank requires a 28 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 14 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10 percent. Compensating balances will be subtracted from the $151,000 in determining the available funds in part a. a. Calculate the effective interest rate for Fidelity Bank and Southwest Bank. Which loan should Summit accept? b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains $42,280 at each bank in deposits that will serve as compensating balances. c. Does your choice of banks change if the assumption in part b is correct?

Answer 1

Calculations are needed to determine the effective interest rates for Fidelity Bank and Southwest Bank by considering compensating balances and repayment schedules to advise Summit Record Company on which loan to accept.

Step-by-step explanation:

The student's question involves calculating the effective interest rate for two loans from different banks, taking into account compensating balances and repayment schedules. It is a problem focused on understanding the true cost of borrowing when considering various loan terms.

To calculate the effective interest rate for Fidelity Bank, which requires a 28 percent compensating balance and discounts the loan paid back in four quarterly payments, and for Southwest Bank, which requires a 14 percent compensating balance without discounting the loan, to be paid in 12 monthly installments, we would need to incorporate the compensating balances and the payment schedules into our calculations. These calculations would provide the effective interest rate for each option, allowing Summit Record Company to decide which loan is more advantageous.

It's important to consider that if Summit ordinarily maintains $42,280 at each bank in deposits that will serve as compensating balances, the effective cost of the interest may change, and thus the choice between the banks could be different as well.