Question

New York Bank provides Food Canning, Inc. a $250,000 line of credit with an interest rate of 1.75 percent per quarter. The credit line also requires that 1 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance. Food Canning, Inc.'s short-term investments are paying 1.2 percent per quarter. What is the effective annual interest rate on this arrangement if the line of credit goes unused all year

Answer 1

effective interest rate: 2.37%

Step-by-step explanation:

250,000 x 1% = 2,500

We will calcualtethe interest expense for the credit line and the interest revneue for the credit being in short-term investment through the whole year

so we got:

`Principal \: (1+ r)^(time) = Amount`

Principal 250,000.00

time 4.00

rate 0.00175

`250000 \: (1+ 0.00175)^(4) = Amount`

Amount 267,964.76

interst expense for the credit line 17.964.76

2,500 will be deposited

if we keep the credit line available through short term investment we will got:

`Principal \: (1+ r)^(time) = Amount`

Principal 247,500.00

time 4.00

rate 0.01200

`247500 \: (1+ 0.012)^(4) = Amount`

Amount 259,595.56

interest revenue 12.095,56‬

so we recieve 247,500

and paid 17.964.76 interest

and gain 12.095,56‬

interest net: 5.869,2‬

5,869.2/247,500 =0,02371393 = 2.37%