You\'ve worked out a line of credit arrangement that allows you to borrow up to

Question

You've worked out a line of credit arrangement that allows you to borrow up to $65 million at any time. The interest rate is 0.7 percent per month. In addition, 5 percent of the amount that you borrow must be deposited in a non-interest-bearing account. Assume that your bank uses compound interest on its line of credit loans. Required: (a) The effective annual interest rate on this lending arrangement is_____ percent. (b) Suppose you need $17 million today and you repay it in 10 months. You will pay $_____ in interest.

Explanation / Answer

The compound interest formula is I = P((1+r)n -1 )

So we know that the monthly rate is 0.7 so r= 0.0007
1year =12 months = n= 12

Assume that the yearly compound rate is x

CI (totat 12 months) = put r= 0.007 , n = 12, in formula

CI (annual ) = put r= x in formula, n = 1

Equating both we get,
1+x = (1+0.007)12

x= 0.0873

SO annual interest rate is 8.73 %   - ANS 1

Apply formula ,
I = 17((1+0.007)10-1 )
P = 17 million

r=0.007
n= 10
I = 1.2281 million dollars

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