Question

What it be worth it to incur a compensating balance of $2000 in order to get a 1.5% lower interest rate on a one year, pure discount loan of $100,000?

Would it be worth it to incur a compensating balance of $2000 in order to get a 1.5% lower interest rate on a one year pier discount loan of $100,000?

Answer 1

Yes it would be worth to incur a compensating balance of $2000 in order to get a 1.5% lower interest rate on a pure discount loan.

Reason:

Pure discount loan means lender will lend you certain money after discounting the amount which means borrower will receive the money today and will have to pay the loan amount in the single lum sum.Suppose if the borrower get lower interest rate of 1.5% which means borrower will have to pay $100000 * 1.5% = $1500 less on maturity and have to maintain $2000 as compensating balance which is not an expense but a kind of minimum balance to be maintain with bank.The borrower will only loose the interest on $2000 and will save $1500 after one year in return and in any case we can't get return of $1500 on $2000 if we doesn't maintain the compensating balance and get it invested so it will be better to maintain compensating balance and get 1.5% extra discount.