Your bank offers you a $40,000 line of credit with an interest rate of 2.35% per

Question

Your bank offers you a $40,000 line of credit with an interest rate of 2.35% per quarter. The loan agreement also requires that 5% of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Your short-term investments are paying 1.75% per quarter. What is your effective annual interest rate if you borrow the whole $40,000 for the entire year? Assume that both the funds you borrow and the funds you invest use compound interest.

a) 9.40%

b) 9.63%

c) 9.74%

d) 9.82%

e) 9.87%

Explanation / Answer

Effective Annual Rate = (1 + 0.0235)^4 - 1

Effective Annual Rate = 0.09736 = 9.736%

9.74%............answer

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