Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percent-lower interest rate on a 1-year, pure discount loan of $500,000? A) yes B) no C) not enough information is given to know It depends upon whether $500,000 x (1 + i) or $510,000 x (1 + [i -.01]) is larger. The compensating balance for the lower loan rate will make sense if: $500,000 x (1 + i ) $510,000 x (1 + [i -.01]) ($500,000/$510,000) x (1 + i) (1 + [i - .01]) )9804 + .9804i 1 + i - .01 -)0196i .0096 I

Question

Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percent-lower interest rate on a 1-year, pure discount loan of $500,000?
A) yes
B) no
C) not enough information is given to know It depends upon whether $500,000 x (1 + i) or $510,000 x (1 + [i -.01]) is larger. The compensating balance for the lower loan rate will make sense if:
$500,000 x (1 + i ) > $510,000 x (1 + [i -.01])
($500,000/$510,000) x (1 + i) > (1 + [i - .01])
)9804 + .9804i > 1 + i - .01
-)0196i > .0096
I < -.4697959
In other words, only if the rate is less than -46.98%. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

Quizplus · Accepted Answer

Calculation shows that the interest rate would need to be less than -46.98% for the compensating balance to be worth it, which is not likely to happen. Therefore, it is not worth incurring the compensating balance for a 1-percent-lower interest rate on the loan.

Would It Be Worth It to Incur a Compensating Balance