Question

Jim's Electrical is offered a $400,000 line of credit for six months at an APR of 9%. The bank requires that the firm keep an amount equal to 5% of the loan principal in a non-interest-earning account with the bank as long as the loan remains outstanding. What is the actual six-month interest rate paid, expressed as an EAR?

Answer 1

Answer:

9.90%

Explanation:

The appropriate approach is to include the amount expected to kept in non-interest bearing account as part of the loan

total loan=$400,000/0.95= 421,052.63  

Interest charge = 421,052.63*9%*6/12=$18,947.37  

interest rate percentage=$18,947.37/$400,000=4.74%

Effective annual rate=(1+4.74% /6)^12-1  =9.90%

By dividing by 6, the interest is expressed in monthly terms

By raising to the power of 12 , it is expressed in yearly terms