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Kerry Corporation must pay $500,000 to its supplier. Kerry's bank has offered a 270-day simple interest...

Kerry Corporation must pay $500,000 to its supplier. Kerry's bank has offered a 270-day simple interest loan with a quoted interest rate of 12 percent. The bank requires a 20 percent compensating balance requirement on business loans. If Kerry currently holds no funds at the lending bank, what is the loan's effective annual rate (rEAR)? In your computations, assume there are 360 days in a year.

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Answer #1

Solution :-

Kerry need to pay supplier = $500000

Compensating balance requirement = 20%

Therefore amount of loan taken from bank =

= $500,000/(1-0.20)

= $625000

Out of which 500000 pay to supplier and 125000 deposit to Bank as compensating balance

Interest need to pay = $625000 * 12%* 270/360 = $56250

Now the Effective Annual rate =

( $56250 / $500000 ) * 360/270 = 0.15 = 15%

If there is any doubt please ask in comments

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