Question

Dr. Ruth is going to borrow $5,000 to help write a book. The loan is for one year and the money can be borrowed at either the prime rate or the LIBOR rate. Assume the prime rate is 11% and LIBOR 1.5% less. Also assume there will be a $45 transaction fee with LIBOR (this amount must be added to the interest cost with LIBOR). Which load has the lower effective interest cost?

Answer 1

LIBOR would be cheaper i.e. 10.40% as compared with the prime 11%

Step-by-step explanation:

The effective interest rate is

But before that

The effective interest is

= (9.5% of $5,000) + $45

= $520

Now the effective interest rate is

= 520 ÷ $5,000 × 360 days ÷ 360 days

= 10.40%

And, the prime rate is 11%

So the LIBOR rate would contain the less effective interest cost