Question

Finance. What interest rate would make it worthwhile to incur a compensating balance of $17,500 in order to get a 0.65-percent lower interest rate on a 2-year, pure discount loan of $250,000? (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)

Answer 1

It depends upon whether $250,000 * (1 + i) or $267,500 * (1 + [i – 0.0065]) is larger.

The compensating balance for the lower loan rate will make sense if: $250,000 * (1+i) > $267,500 * (1+[i – 0.0065])

$250,000 * (1+i) > (1+[i – 0.0065]) $267,500

(250,000/267500) * (1+i) > (1+[i – 0.0065])

0.9346 + 0.9346i > 1 + i – 0.0065
i - 0.9346i > 1 - 0.9346 - 0.0065

–0.0654i > 0.0589

i < -90.06%

The compensating balance of $17,500 would make sense only if the interest is lower than -90.06%