Question

The treasurer of Brandon Blue Sox is seeking a $26,000 loan for 180 days from the Brandon Credit Union. The stated interest rate is 12 percent and there is a 20 percent compensating balance requirement. The treasurer always keeps a minimum of $2,100 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: Depending on credit history of a customer, Bank/Financial Institution may ask to keep certain amount as deposit to qualify for the loan. This deposit is known as a compensating balance. In case customer fails to repay the loan, bank can seize the compensating balance.

In the given case, The treasurer of Brandon Blue Sox is seeking a $26,000 loan for 180 days from the Brandon Credit Union and required compensating balace is 20%. i.e.,$26000*20%= $5200

Stated interest rate was 12%., But if there is a compensating balance then effective interest rate would be higher than stated interest rate. Subtract the compensatory balance from the total principal to calculate the available balance.

Available balance = Loan amount - Compensating balance

=$26000-$5200

=$20,800

But the treasurer always keeps a minimum of $2,100 in the firm’s chequing account. These funds could count toward meeting any compensating balance requirements. This amount has to be added with above available balance

Therefore total available balance = $20,800+$2,100

=$22,900.

Total Interest on the loan amount = Prinicipal amount*Interest rate

=$26000*12/100*180/365

=$1538.63

Effective Interest rate = Total Interest/Total available balance

=$1538.63/$22,900*365/180

=13.62% p.a