A firm has a $500,000 line of credit with a 3.8% compensating balance requiremen

Question

A firm has a $500,000 line of credit with a 3.8% compensating balance requirement. The quoted rate on the line is prime +3.5%, and the prime rate is currently 2.5%. What is the effective annual rate (EAR)? Note: You don't need to know how much the firm borrows, the EAR will be the same for all borrowings $200,000 or less. However for convenience in calculations, you may assume that the firm borrows $100,000. Express your answer as a percentage, for example 3.18% should be entered as 3.18 without the percentage sign.

Explanation / Answer

EAR=borrowing*interest rate/(borrowing-compensating balance)=100000*(3.5%+2.5%)/(100000-100000*3.8%)=6.237%

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