Question

4. (Compensating Balance) Quick Loan Bank offers your firm a line of credit at 8.25% annually up to $25 million. In addition, the bank requires you to maintain a 5% compensating balance against the amount you borrowed. What is the effective interest rate on this line of credit

Answer 1

9.51%

Step-by-step explanation:

In this question, we are interested in calculating the effective interest rate on this line of credit

Firstly, we calculate the interest value = 8.25% * 25 million = 2,062,500

Next is to calculate the compensating balance = 5% of 25 million = 1,250,000

Mathematically;

Effective interest rate = interest/(loan - interest - compensating balance)

Effective Interest rate = 2062500/(25000000-1250000-2062500)) = 0.0951

= 9.51%