In exchange for a $400 million fixed commitment line of credit, your firm has ag
ID: 2737117 • Letter: I
Question
In exchange for a $400 million fixed commitment line of credit, your firm has agreed to do the following:
1. Pay 1.81 percent per quarter on any funds actually borrowed.
2. Maintain a 5 percent compensating balance on any funds actually borrowed.
3. Pay an up-front commitment fee of 0.26 percent of the amount of the line.
The effective annual interest rate on this line of credit is 7.83%
Suppose your firm immediately uses $211 million of the line and pays it off in one year. What is the effective annual interest rate on this $211 million loan?
Explanation / Answer
The effective annual interest rate is = (Interest + Commitment) / (Amt Borrowed * (1-compensating balance %))
The interest rate to be used in the formual is = (1+0.0181)^4 -1 = 0.074389486
Interest =0.074389486 * 211,000,000 = 15,696,182
Commitment = 0.26% of 400,000,000 = 1,040,000 (Since this is on the line of credit)
Amout borrowed = 211,000,000
compesating balance % = 5% = 0.05
Hence effective annual interst = (15,696,182 + 1,040,000)/(211,000,000*(1-0.05)) = 0.0835
Effective annual interest = 0.0835 = 8.35%