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 $9,000 in order to get a 0.70 percent lower interest rate on a 1-year,pure discount loan of $250,000?

• A)Yes
• B)No
• C)Not enough information is given to determine The repayment on the $250,000 loan without the compensating balance would be $250,000 × (1 + i), vs.$259,000 × (1 + [i - 0.007]):
• $250,000 × (1 + i) > $259,000 × (1 + [i - 0.007])
• ($250,000/$259,000) × (1 + i) > (1 + [i - 0.007])
• 0)9653 + 0.9653i > 1 + i - 0.007
• -0)0347i > 0.0277
• I < -0.7983
• In other words, only if the rate is less than -79.83 percent.Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

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Definitions:

Record

A document or entity that preserves information or data for future reference.

Law of Averages

A layman's term often misused to suggest that a future event is likely to occur to balance out a statistical deviation, though not a formal statistical principle.

Independent Events

Two or more events whose outcomes do not affect each other's probabilities of occurring.

Positive Difference

The result of subtracting a smaller number from a larger number, ensuring a non-negative result.