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Unformatted text preview: l be 10% (9% 1%), but when the prime rate changes, so will
the rate of interest on the note. For instance, if after 30 days the prime rate rises
to 9.5%, and after another 30 days it drops to 9.25%, the firm will be paying
0.833% for the first 30 days (10% 30/360), 0.875% for the next 30 days
(10.5% 30/360), and 0.854% for the last 30 days (10.25% 30/360). Its total
interest cost will be $2,562 [$100,000 (0.833% 0.875% 0.854%)], resulting in an effective 90-day rate of 2.562% ($2,562/$100,000).
Again, assuming the loan is rolled over each 90 days throughout the year
under the same terms and circumstances, its effective annual rate is 10.65%:
Effective annual rate (1 0.02562)4 1
1.1065 1 0.1065 10.65% Clearly, in this case the floating-rate loan would have been less expensive than
the fixed-rate loan because of its generally lower effective annual rate. Lines of Credit
line of credit
An agreement between a
commercial bank and a business
specifying the amount of
unsecured short-term borrowing
the bank will make available to
the firm over a given period of
time. A line of credit is an agreement between a commercial bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. It is similar to the agreement under
which issuers of bank credit cards, such as MasterCard, Visa, and Discover,
extend preapproved credit to cardholders. A line-of-credit agreement is typically
made for a period of 1 year and often places certain constraints on the borrower.
It is not a guaranteed loan but indicates that if the bank has sufficient funds available, it will allow the borrower to owe it up to a certain amount of money. The
amount of a line of credit is the maximum amount the firm can owe the bank at
any point in time.
When applying for a line of credit, the borrower may be required to submit
such documents as its cash budget, its pro forma income statement, its pro forma
balance sheet, and its recent financial stat...
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