Answer:
a) 4.27 %
b) 7.14%
c) 6.97%
Explanation:
a)
The effective annual interest rate (EAR) of your investment account is:
EAR = 1.0105⁴ – 1
EAR = 0.0427
EAR = 4.27 %
b)
The effective annual interest rate on the lending arrangement can be determined by the division of the interest on the loan by the amount of the loan.
Now to determine the interest cost on the loan ; we need to first find the opportunity cost of the compensation balace.
So;
opportunity cost of the compensation balace is as follows:
= 0.04 ($68,000,000 – $ 35,00,000) (1.0105)⁴ – 0.04 ($68,00,000 – $35,000,000)
= 0.04 (33,000,000) × 1.04267 – 0.04 (33,000,000)
= 1,376,324.4 – 1,320,000
= $56,324.4
Interest Cost = 35,000,000 (1.0170)⁴ – 35,000,000
=35,000,000 × 1.069753735521– 35,000,000
=$2,441,380.74
Finally ; since we know the interest cost ; the EAR of the loan in the amount of $35,000,000 is
:
EAR = (56324.4 + 2441380.74 ) / 35,000,000
=0.0714
= 7.14%
c)
The compensating balance is only applied to the unused portion of the credit line, so the EAR of a loan on the full credit line is:
EAR = 1.0170⁴ – 1
=0.06975
= 6.97%
