You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
-Suppose you borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest prepaid (a discounted loan) . Also, assume that the bank requires you to maintain a compensating balance equal to 20 percent of the initial loan value. What effective annual interest rate are you being charged?

Question

Quizplus · Accepted Answer

The effective annual interest rate is calculated by considering the actual amount received after the compensating balance and the interest paid. The loan is discounted, so you receive less than $2,000. The compensating balance further reduces the amount you can use. The effective interest rate is higher than the nominal rate due to these factors.

You Have Just Taken Out a Loan for $75,000