1.A financial institution made a $4 million, 1-year discount loan at 6% interest, requiring a compensating balance equal to 5% of the face value of the loan. Determine the effective annual rate associated with this loan. (Note: Assume that the firm currently maintains $0 on deposit in the financial institution.)

 

2.Lincoln Industries has a line of credit at Bank Two that requires it to pay 11% interest on its borrowing and to maintain a compensating balance equal to 15% of the amount borrowed. The firm has borrowed $800,000 during the year under the agreement.

a. Calculate the effective annual rate on the firm’s borrowing if the firm normally maintains no deposit balances at Bank Two.

b. Calculate the effective annual rate on the firm’s borrowing if the firm normally maintains $70,000 in deposit balances at Bank Two.

c. Calculate the effective annual rate on the firm’s borrowing if the firm normally

maintains $150,000 in deposit balances at Bank Two.

d. Compare, contrast, and discuss your findings in parts a, b, and c.