Would It Be Worth It to Incur a Compensating Balance

question 85

Multiple Choice

Would it be worth it to incur a compensating balance of $15,000 in order to get a 2-percent-lower interest rate on a 1-year, pure discount loan of $1,000,000?

• A) yes
• B) no
• C) not enough information is given to determine It depends upon whether $1,000,000 x (1 + i) or $1,015,000 x (1 + [i - .02]) is larger. The compensating balance for the lower loan rate will make sense if:
• $1,000,000 x (1 + i) > $1,015,000 x (1 + [i - .02])
• ($1,000,000/$1,015,000) x (1 + i) > (1 + [i - .02])
• )9852 + .9852i > 1 + i - .02
• -)0148i > -.0052
• I < .35135
• In other words, only if the rate is less than 35.14%. Since this is likely to happen, the lower rate associated with the compensating balance is worth it.

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Definitions:

Duty Not to Compete

A legal agreement where one party agrees not to enter into or start a similar profession or trade in competition against another party.

Restrictive Covenants

Clauses in contracts or agreements that limit certain actions of the parties involved, often to protect business interests.

Public Interest

A common concern among citizens in the management and affairs of local, state, and national government that serves the community well-being as opposed to the benefit of individuals.

Fiduciary Duty

A legal obligation of one party to act in the best interest of another party, often found in relationships involving trust, such as between a trustee and beneficiary.