Consider two loans with a 1-year maturity and identical face values: a 7.6% loan with a 0.97% loan origination fee and a 7.6% loan with a 4.7% (no-interest) compensating balance requirement. Which loan would have the higher effective annual rate? Why?
Consider two loans with a 1-year maturity and identical face values: a 7.6% loan with a 0.97% loan origination fee and a 7.6% loan with a 4.7% (no-interest) compensating balance requirement. Which loan would have the higher effective annual rate? Why?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Hello
Can you show how to calculate the compensating balance requirement?
In my solution guide i have this:
76/953 = 7.975%
My question:
Why do we devide 76/953 and not say 1076/953 to calulate the effective annual cost?
Transcribed Image Text:2. Consider two loans with a 1-year maturity and identical face values: a 7.6% loan with a 0.97% loan origination
fee and a 7.6% loan with a 4.7% (no-interest) compensating balance requirement. Which loan would have the
higher effective annual rate? Why?
Transcribed Image Text:7
Chapter 27 - Problem 2
For a loan with the 0.97% loan origination fee would, on a $1,000 loan, the
borrower is paying $9.7 initially and will have the use of only $990.3 for the
period, making the effective annual cost of the loan equal to
1076
1 = 8.65%
(1)
990.3
The compensating balance requirement of 4.7% on a $1,000 loan reduces the
usable proceeds of the firm by 4.7% to $953, and the interest rate is still
7.6%, so the effective annual cost of that arrangement is
76
= 7.975%
953
(2)
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