Question

1) I offer to borrow money from you for 60 days at the following interest rate quotations:

A. a discount rate of 8.30%.

B. a simple interest money market rate of 8.37%.

C. a “bond equivalent” yield (simple interest 365 day) rate of 8.45%.    

Which is the better deal from your point of view?   Why?

Answer 1

Let the initial borrowing be $ 100 and the given borrowing tenure = 60 days.

(a) Discount Borrowing with rate of 8.3 % per annum. A discount borrowing implies that the borrower repays the the initially borrowed $ 100 at maturity.

Therefore, Initial Value of Borrowing = 100 / [1+(8.3/100)]^(60/365) = $98.6978 ~ $ 98.7

Borrowing Expense = [(100-98.7) / 98.7] x 100 = 1.319 %

(b) Simple Interest Money Market Rate = 8.37 % , a money market rate assumes that there are 360 days in a year.

Therefore, Applicable Interest Rate = 8.37 x (60/360) = 1.395%

Interest Expense = 100 x (1.395/100) = $ 1.395

Total Payment = 101.395 $

Borrowing Expense = 1.395 %

(c) Bone Equivalent Yield = 8.45 %

Applicable Interest Rate = 8.45 x (60/365) = 1.389%

Interest Expense = (1.389/100) x 100 = $ 1.389

Borrowing Expense = (1.389/100) x 100 = 1.389%

As I am the lender I would be benefited the most when the borrowing expense is maximum. Hence, option (C) is the best option for the lender.