a. What interest rate would make it worthwhile to incur a compensating balance o

Question

a.  
What interest rate would make it worthwhile to incur a compensating balance of $13,000 in order to get a 1 percent lower interest rate on a 1 year, pure discount loan of $240,000? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)

Interest rate   %

b.  
Is it worth incurring the compensating balance to obtain the lower rate?

   Yes
   No

This did not get answered correctly the first time I posted it. I can't seem to figure out the interest. Can you show your work?

Explanation / Answer

a) Loan Amount = $240,000

Estimated Compensating Balance: $13,000

% of Loan Amount = 5.42%

Please note: Effective Interest rate on any loan amount (before compensating balance) is always lesser than the loan with a compensating balance.

Here, if the interest rate is assumed to be zero, Interest charge: $0

With compensating balance of $ 13,000,

Effective Interest rate: Interest Amount / (Loan Amount - Compensating balance)

=0%

However, when the interest rates turn negative, effective interest rate on any loan amount (before compensating balance) is always lesser than the loan with a compensating balance

i.e. the answer after rounding off is: -0.01%

b) YES, as the compensating balance amount of Rs.13,000 will yield negative returns at the current interest rate scenario.

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