US CMA Part 2 · Chapter 4 · Question 2 of 15
Fairmont Corp. borrows $500,000 for one year at a stated rate of 8%. The bank requires a 10% compensating balance in a non-interest-bearing account; Fairmont does not otherwise keep cash with the bank. What is the effective annual interest rate?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) 8.89%
Explanation
Interest = $500,000 x 8% = $40,000. Usable funds = $500,000 x (1 - 10%) = $450,000. Effective rate = $40,000 / $450,000 = 8.89%. 8.70% would be the effective rate of a discount loan with no compensating balance.
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