Question

Your bank offers you a $40,000 line of credit with an interest rate of 1.75 percent per quarter. The loan agreement also requires that 2 percent of the unused portion of the credit line be deposited in a non-interest-bearing account as a compensating balance. Your short-term investments are paying .15 percent per month. What is your effective annual interest rate on this arrangement if you do not borrow any money on this credit line during the year? Assume any funds borrowed or invested use compound interest.

How do you get 1.81?

A.

7.19 percent

B.

1.81 percent

C.

3.18 percent

D.

.87 percent

E.

.60 percen

Answer 1

The effective annual interest rate on this credit line arrangement, assuming no borrowing is done, is -0.2%.

Step-by-step explanation:

To find the effective annual interest rate, we need to consider the interest earned from short-term investments and the compensating balance required by the loan agreement.

The interest earned from short-term investments is 0.15% per month, which is equivalent to 1.8% per year.

However, 2% of the unused portion of the credit line is required to be deposited in a non-interest-bearing account as a compensating balance.

Therefore, the effective annual interest rate considering both factors is 1.8% - 2% = -0.2%.

So the effective annual interest rate on this credit line arrangement, assuming no borrowing is done, is -0.2%.