Would It Be Worth It to Incur a Compensating Balance

question 71

Multiple Choice

Would it be worth it to incur a compensating balance of $10,000 in order to get a 1-percent-lower interest rate on a 1-year, pure discount loan of $500,000?

• A) yes
• B) no
• C) not enough information is given to know It depends upon whether $500,000 x (1 + i) or $510,000 x (1 + [i -.01]) is larger. The compensating balance for the lower loan rate will make sense if:
• $500,000 x (1 + i ) > $510,000 x (1 + [i -.01])
• ($500,000/$510,000) x (1 + i) > (1 + [i - .01])
• )9804 + .9804i > 1 + i - .01
• -)0196i > .0096
• I < -.4697959
• In other words, only if the rate is less than -46.98%. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

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