Would It Be Worth It to Incur a Compensating Balance

question 7

Multiple Choice

Would it be worth it to incur a compensating balance of $2,000 in order to get a 1.5-percent-lower interest rate on a 1-year, pure discount loan of $100,000?

• A) yes
• B) no
• C) not enough information is given to determine It depends upon whether $100,000 x (1 + i) or $102,000 x (1 + [i - .015]) is larger. The compensating balance for the lower loan rate will make sense if:
• $100,000 x (1 + i) > $102,000 x (1 + [i - .015])
• ($100,000/$102,000) x (1 + i) > (1 + [i - .015])
• )9804 + .9804i > 1 + i - .015
• -)0196i > .0046
• I < -.234694
• In other words, only if the rate is less than - 23.47%. Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

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