In a discount interest loan, you pay the interest payment up front. For example,
ID: 2736102 • Letter: I
Question
In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $48,000 and the interest rate is 7.75%, the borrower "pays" .0775 times $48,000 = $3,720 immediately, thereby receiving net funds of $44,280 and repaying $48.000 in a year. What is the effective interest rate on this loan? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) What is the effective annual rate on a 1-year loan with an interest rate quoted on a discount basis of 17.75%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)Explanation / Answer
a. Effective rate of interest = 3720/44280 x 100 = 8.40%
b. Interest under this loan = 48000 x 17.75% = $8520
Proceeds = 48000 - 8520 = $39480
Effective annual rate = 8520 / 39480 x 100 = 21.58%