Question

Mr. Fernandez has applied for a revolving credit line of $ 2 million to assist in marketing a new product line. The terms of the loan will be as follows:

(a) All the loans will be discount loans.

(b) A fixed commitment fee of 0.5 percent will be charged.

(c) The compensatory balance requirements will be 9 percent on the total credit line and 6 percent on the outstanding loans. (

d) The bank will pay 1 percent interest on demand deposits.

(e) The rate of interest to be charged will be the prime rate plus 3 percent.

(f) The bank will use the "actual/360" accrual method to compute interest payments.

(g) The credit line will be extended for a period of five years.

The loan officer estimates that Mr. Fernandez will use about 61 percent of the credit line on average. If the prime rate is 10 percent and the required reserve rate on demand deposits is 14 percent, what is the effective cost to Mr. Fernandez? (Step-by-Step, Use formulas)

Answer 1

Credit Line	20,00,000
Discount Loan	Yes
Commitment charges	0.50%
Compansatory Balance	9% on total credit line and 6% on utilisation
Interest rate on deposit	1%
Interest rate on loan	3% + prime rate
Prime Rate	10%
utilisation	61%
Required reserve rate	14%
Compansatory Balance	2,53,200
Utilisation of Loan	12,20,000
Simple Interest rate	13.000%
Cost to Mr Fernandez
Commitment charges	10,000.00
Interest charges on Borrowed fund	1,58,600
Interest cost on Companstory Balance	32,916
Less Interest cost earned on compansatory balance	-2,532
	1,98,984
Effective rate for Mr Fernandez	16.31%