Question

On April 31, 2016, Elkhorn associates borrowed $10 million from Colonial Bank and issued a five month non-interest bearing note. Effective interest rates are at 10%. The stated discount rate on the loan is:

1) More than
2) Less than
3) Equal to

Answer 1

The question revolves around comparing the stated discount rate on a loan to the effective interest rate for Elkhorn Associates' borrowing from Colonial Bank.

Step-by-step explanation:

The student's question relates to the determination of the stated discount rate on a loan compared to the effective interest rate. On April 31, 2016, Elkhorn Associates borrowed $10 million from Colonial Bank with an effective interest rate of 10%. The student is asked to compare this effective interest rate to the stated discount rate on the five-month non-interest-bearing note.

To provide an answer, we must understand that a non-interest-bearing note means that rather than paying periodic interest, the interest cost is factored in upfront in the form of a discount from the face value of the note. The effective interest rate provides a true picture of the cost of borrowing when compounding is considered. Given that this is a short-term note, the effective interest rate and the stated discount rate could differ because the discount rate does not take into account the compounding effect within the borrowing period.

Since the actual question about whether the discount rate is higher, lower or equal to the effective interest rate is missing the specific rate to compare, we can only discuss the relationship between the two rates. If the effective annual rate is at 10%, the discount rate would typically be lower because it's not considering the effect of compounding interest.