Tangshan Mining borrowed $100,000 for one year under a line of credit with a stated interest rate of 7.5 percent and a 15 percent compensating balance. Normally, the firm keeps a balance of about $10,000 in its checking account. Based on this information, the effective annual interest rate on the loan was
A) 7.89%.
B) 8.05%.
C) 8.89%.
D) 7.29%.

Question

Quizplus · Accepted Answer

The effective annual interest rate on the loan is 7.89%.The compensating balance is the minimum balance that a borrower must maintain in a checking account with the lender. In this case, the compensating balance is 15% of the loan amount, or $15,000. The effective annual interest rate is the stated interest rate plus the compensating balance divided by the loan amount minus the compensating balance. In this case, the effective annual interest rate is 7.5% + (15% x $100,000) / ($100,000 - $15,000) = 7.89%.

Tangshan Mining Borrowed $100,000 for One Year Under a Line