Question

2. A compensating balance is a term for a loan that usually results in a higher effective interest rate than a simple interest rate. Is there ever a situation when requiring a compensating balance does not result in a higher effective interest rate than a simple interest rate for the loan? Explain your answer.

Answer 1

When a business takes out a loan.

Explanation:

Businesses is charged a lower interest rate on a loan. This also increases the cost of capital for the borrower. They use a loan to pay for expenses which is sometimes due to bankruptcy.

Sol:

The only situation when Compound Interest is not Higher than Simple Interest when Interest charge For 1st year and Compounding on annual basis.

Example :

Amount Deposit = 100

Rate = 10%

Compounding annually

Compute simple and compound interest :

Simple interest = P* r* n

= 100 * 10% * 1

= 10

Compound interest =P(1+rate/t)^^{n t} -1

= 100 (1+10% )^¹ -1

= 10

Compound interest is method of charging interest, in compound interest method interest charge on principle as well on Interest, in other words interest in interest.

Formula = P(1+rate/t)^^{n t} -1

P = amount invested or deposited

Rate = interest rate

N = no of period

t= no of times compound

Simple Interest = Simple interest is a method of charging interest on Amount deposit or Principle amount

Formula = P * r * n