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29 June, 20:47

Rockville Corporation is going to borrow $250,000 from its bank at an APR of 8.5 percent. The bank requires its customers to maintain a 10 percent compensating balance. What is the effective interest rate on this bank loan? Round to 4 decimal places and enter percentages as a decimal

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Answers (2)
  1. 29 June, 22:26
    0
    9.4%

    Explanation:

    Compensating balance amount = $250,000 * 10% = $25,000

    Interest expenses = $250,000 * 8.5% = 21,250

    Effective interest rate = $21,250 / ($250,000 - $25,000) = 0.0944, or 9.4%

    Therefor, the effective interest rate is 9.4%.

    Note: The effective interest rate of 9.4% is higher than the APR of 8.5% because of the compensating balance.
  2. 29 June, 22:42
    0
    Answer: 0.0944 (4 dp)

    Explanation:

    To calculate the effective interest rate we will go in stages.

    First we calculate the compensated balance deposit of 10%,

    = 250,000*10%

    = $,25,000

    Subtracting it from the loan amount will give us the effective borrowing.

    Effective borrowing = 250,000-25,000

    = $225,000

    Then we find out the interest expense on the original amount which is,

    Interest expense = Amount borrowed * Interest rate

    = 250,000*8.5%

    = $21,250

    The reason we calculated the above is because we need that figure in the effective interest rate formula which goes like,

    Effective interest rate = Interest expense / Effective borrowing amount

    = 21,250/225,000

    = 0.094444444

    = 0.0944

    Effective interest rate is 0.0944 (4 dp)
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