You have a line of credit arrangement which allows you to borrow up to $80 milli

Question

You have a line of credit arrangement which allows you to borrow up to $80 million at any time. The interest rate is 0.63% per month. The arrangement also requires a compensating balance equal to 6% of the amount borrowed which must be placed in a non-interest-bearing account. The bank uses compound interest on its LOC loans.

a. If you borrow the entire line, how much will you actually be able to use?

b. How much is your monthly interest payment? What is your periodic interest rate and EAR?

c. If you need $19 million and repay it in 10 months, how much interest will you pay?

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Explanation / Answer

a) If entire credit line is used the 6% has to be kept in non interest bearing account so amount actually available for utilisation would be: 94% of $80 million = $75.2 million.

b)Monthly interest payment = loan * Monthly interest = $80*0.63% = $0.504 Million

   Periodic interest rate = (interest paid/actual utilised amount) *100 = (0.504/75.2)* 100= 0.67% per month

Yearly rate = 0.67*12 = 8.04 % per annum

c) If $19 million is required then 6% of utislised amount should be kept in non interest bearing account. so let amount utilised be 'X'

now X= 19 + 6% of X

     or,   X - 0.06X = 19

    or. 0.94X = 19

   or X = 20.213

So actual amount of loan would be 20.213 out of which 1.213 would be kept in non interest bearing account.

hence interest on 20.213 for 10 months = Loan * Monthly Interest in % * 10

    = 20.213 * 0.63% * 10 = $1.273 million.

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