Tangshan Mining borrowed $10,000 for one year under a line of credit with a stated interest rate of 8 percent and a 10 percent compensating balance. Normally, the firm keeps almost no money in its checking account. Based on this information, the effective annual interest rate on the loan was 8.89 percent.

Question

Quizplus · Accepted Answer

The effective annual interest rate is calculated by considering the compensating balance requirement, which effectively reduces the amount of usable funds. The formula for the effective rate is: (Interest / Usable Funds) * 100. Here, the usable funds are $9,000 ($10,000 - $1,000 compensating balance), so the effective rate is ($800 / $9,000) * 100 = 8.89%.

Tangshan Mining Borrowed $10,000 for One Year Under a Line