7. Compensating balance versus discount loan Weathers Catering Supply, Inc., nee

Question

7. Compensating balance versus discount loan Weathers Catering Supply, Inc., needs to borrow $147,000 for 6 months. State Bank has offered to lend the funds at an annual rate of 8.5 % subject to a 9.6 % compensating balance.

(Note:Weathers currently maintains $ 0 on deposit in State Bank.) Frost Finance Co. has offered to lend the funds at an annual rate of 8.5 % with discount-loan terms. The principal of both loans would be payable at maturity as a single sum.

a.Calculate the effective annual rate of interest on each loan.

b.What could Weathers do that would reduce the effective annual rate on the State Bank loan?

Round all answers to two decimal places

Explanation / Answer

a)

Effective annual rate on loan from Statebank= interest/amount borrowed - compensating balance

= 147000 * 8.5%/ 147000 - 147000*9.6%

= 12495/132888

= 9.40%

Effective annual rate on loan from frost= interest/amount borrowed - interest

= 147000 * 8.5%/ 147000 - 147000*8.5%

= 12495/134505

= 9.29%

b)

it should open bank account with state bank so as to reduce effective annual rate . Opening new account will reduce compensating balanace

Related Questions

Navigate

• Browse (All)
• Browse 7
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.