Your bank offers you a $100,000 line of credit with an interest rate of 2.5% per

Question

Your bank offers you a $100,000 line of credit with an interest rate of 2.5% per quarter. The loan agreement also requires that 4% of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Your short-term investments are paying 1.25% per quarter. What is your effective annual interest rate if you borrow the whole $100,000 for the entire year? Assume that both the funds you borrow and the funds you invest use compound interest. (Please show work so that I may be able to understand the rationale behind the answer)

Explanation / Answer

10.38 percent

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