Question

The treasurer of Brandon Blue Sox is seeking a $35.000 loan for 180 days from the Brandon Credit Union. The stated interest rate is 12 percent and there is a 15 percent compensating balance requirement. The treasurer always keeps a minimum of $3,000 in the firm's chequing account. These funds could count toward meeting any compensating balance requirements. What is the annual rate of interest on this loan? (Use 365 days in a year. Do not round intermediate calculations. Round the final answer to 2 decimal places.) Annual rate of interest %

Answer 1

Compensating balance is a minimum balance which held in a bank account and borrower cannot use it

Amount of loan = $35,000

Annual interest rate = 12%

Time period of loan = 180 days or 0.5 year

Therefore interest amount for the period = $35,000 * 12% * 0.5 = $2,100

Compensating balance is 15% of the loan

Therefore, Compensating balance = 15% * $35,000 = $5,250

Therefore effective loan amount which company can utilize = Amount of loan - Compensating balance

= $35,000 - $5,250 = $29,750                  (we are not considering minimum balance as compensating balance is more than that)

Therefore effective interest rate = interest amount for the period/ effective loan amount which company can utilize

= $2,100/ $29,750 = 0.07588 or 7.588%

But this interest rate is for 180 days or 0.5 year

The annual effect interest rate on this loan = 2* 7.588% = 14.12%