Unformatted text preview: ces. LG3 15–9 Effective annual rate A financial institution made a $10,000, 1-year discount
loan at 10% interest, requiring a compensating balance equal to 20% of the face
value of the loan. Determine the effective annual rate associated with this loan. LG3 15–10 Compensating balances and effective annual rates Lincoln Industries has a line
of credit at Bank Two that requires it to pay 11% interest on its borrowing and
to maintain a compensating balance equal to 15% of the amount borrowed. The
firm has borrowed $800,000 during the year under the agreement. Calculate the
effective annual rate on the firm’s borrowing in each of the following circumstances:
a. The firm normally maintains no deposit balances at Bank Two.
b. The firm normally maintains $70,000 in deposit balances at Bank Two.
c. The firm normally maintains $150,000 in deposit balances at Bank Two.
d. Compare, contrast, and discuss your findings in parts a, b, and c. LG3 15–11 Compensating balance vs. discount loan Weathers Catering Supply, Inc., needs
to borrow $150,000 for 6 months. State Bank has offered to lend the funds at a
9% annual rate subject to a 10% compensating balance. Frost Finance Co. has
offered to lend the funds at a 9% annual rate with discount-loan terms. The
principal of both loans would be payable at maturity as a single sum.
a. Calculate the effective annual rate of interest on each loan.
b. What could Weathers do that would reduce the effective annual rate on the
State Bank loan? LG3 15–12 Integrative—Comparison of loan terms Cumberland Furniture wishes to establish a prearranged borrowing agreement with its local commercial bank. The
bank’s terms for a line of credit are 3.30% over the prime rate, and each year the
borrowing must be reduced to zero for a 30-day period. For an equivalent
revolving credit agreement, the rate is 2.80% over prime with a commitment fee
of 0.50% on the average unused balance. With both loans, the required compensating balance is equal to 20% of the amount borro...
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