In a discount interest loan, you pay the interest payment up front. For example,

Question

In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $28,000 and the interest rate is 12.25%, the borrower "pays".1225 times $28,000 = $3,430 immediately, thereby receiving net funds of $24,570 and repaying $28.000 in a year. a What is the effective interest rate on this loan? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Effective interest rate % b. What is the elective annual rate on a 1-year loan with an interest rate quoted on a discount basis of 22.25%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Effective annual rate %

Explanation / Answer

Loan Amount = 28000

Interest = 3430

Net funds received = 24570

Effective interest rate = 3430/24570 = 13.96%

Discount basis = 22.25%

Actual value after discount = 100-22.25 = 77.75

Effective annual rate = 22.25/77.75 = 28.62%

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