Question

Mr. Fernandez has applied for a revolving credit line of $ 8 million to assist in marketing a new product line. The terms of the loan will be as follows:
(a) All the loans will be discount loans.
(b) A fixed commitment fee of 0.2 percent will be charged.
(c) The compensatory balance requirements will be 7 percent on the total credit line and 7 percent on the outstanding loans.
(d) The bank will pay 3 percent interest on demand deposits.
(e) The rate of interest to be charged will be the prime rate plus 3 percent.
(f) The bank will use the "actual/360" accrual method to compute interest payments.
(g) The credit line will be extended for a period of five years.
The loan officer estimates that Mr. Fernandez will use about 52 percent of the credit line on average. If the prime rate is 10 percent and the required reserve rate on demand deposits is 12 percent, what is the effective cost to Mr. Fernandez?

Answer 1

Rate of Interest charged by bank = prime rate + 3% = 10+3 = 13%

Interest Rate (accrual method): k= Interest rate (actual/360) = 0.13*(365/360) = 0.1318

Percent of credit line used = 52% i.e 0.52

Compensatory Balance = 7 percent on the total credit line and 7 percent on the outstanding loans. = (0.07+0.07*0.52)

Bank yield =

Bank Yield =

Bank Yield = = 0.1853 i.e 18.53%