Question

Come and Go Bank offers your firm a discount interest loan with an interest rate of 8 percent for up to $17 million, and in addition requires you to maintain a 4 percent compensating balance against the face amount borrowed.
  
What is the effective annual interest rate on this lending arrangement? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Effective annual rate

Answer 1

Given that the interest rate is 8%; and that the face value of amount borrowed is $17 million.

Therefore, amount paid in terms of interest = 17 million * 8% = $1.36 million.

Amount blocked in compensating balance = 17 million * 4% = $680,000. Hence, interest lost due to blocking these funds = 680,000 * 8% = $54,400 per annum.

Hence, total cost of taking the loan = $ 1,360,000 + 54,400 = $ 1,414,400.

Hence, effective rate of interest = $ 1.4144 million / 17million *100 = 8.32% per annum.