Question

kerry corporation must pay $500,000 to its supplier. kerry's bank has offered a 270-day simple interest loan with a quoted interest rate of 12 percent. the bank requires a 20 percent compensating balance requirement on business loans. if kerry currently holds no funds at the lending bank, what is the loan's effective annual rate (rear)? in your computations, assume there are 360 days in a year.

Answer 1

The loan's effective annual rate  (rear) is 15%.

What is the loan's effective annual rate ?

The effective annual interest rate is the true interest rate on an investment or loan because it takes into account the effects of compounding. The more frequent the compounding periods, the higher the rate.

We have

Kerry must pay the supplier $500000.

20% is the required compensating balance.

Due to this, the amount borrowed from the bank is equal to $625,000 ($500,000 divided by 1.020).

500000 of the amount is paid to the supplier, and 125000 is deposited in the bank as a compensatory balance.

Interest due is equal to

$625,000 * 12%.* 270/360 = $56250

Now, the annual effective rate is ($56250 / $500000). * 360/270

= 0.15

= 15%

The loan's effective annual rate  (rear) is 15%.

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