Answer: 0.0944 ( 4 dp)
Explanation:
To calculate the effective interest rate we will go in stages.
First we calculate the compensated balance deposit of 10%,
= 250,000*10%
= $,25,000
Subtracting it from the loan amount will give us the effective borrowing.
Effective borrowing = 250,000-25,000
= $225,000
Then we find out the interest expense on the original amount which is,
Interest expense = Amount borrowed * Interest rate
= 250,000*8.5%
= $21,250
The reason we calculated the above is because we need that figure in the effective interest rate formula which goes like,
Effective interest rate = Interest expense / Effective borrowing amount
= 21,250/225,000
= 0.094444444
= 0.0944
Effective interest rate is 0.0944 ( 4 dp)
Answer:
9.4%
Explanation:
Compensating balance amount = $250,000 * 10% = $25,000
Interest expenses = $250,000 * 8.5% = 21,250
Effective interest rate = $21,250/($250,000 - $25,000) = 0.0944, or 9.4%
Therefor, the effective interest rate is 9.4%.
Note: The effective interest rate of 9.4% is higher than the APR of 8.5% because of the compensating balance.
