The effective rate on a loan with a 7% stated rate and 15% compensating balance is
A) 11%
B) 7.2%
C) 8.2%
D) none of these

Question

Quizplus · Accepted Answer

To calculate the effective rate, we need to first calculate the amount of the compensating balance.

If we borrow $100, only $85 will be disbursed to us because 15% is held as a compensating balance.

The interest will be charged on $100, but we only have access to $85.

So, the effective interest rate can be calculated using the following formula:

Effective rate = (Stated rate x Loan amount) / (Loan amount - Compensating balance)

Effective rate = (7% x $100) / ($100 - $15) = 8.2%

The Effective Rate on a Loan with a 7% Stated