The Lodge borrowed $2,000,000 for five years at an annual interest rate of 9% from the Merchant Bank, which required a $100,000 compensating balance. What was the effective interest rate for the loan? (rounded to the nearest tenth of one percent)

a) 9.0%

b) 9.5%

c) 10.0%

d) 10.5%

option (b) 9.5%

Explanation:

Data provided in the question:

Loan Amount = $2,000,000

Annual interest rate = 9%

Required compensating balance = $100,000

Now,

Effective interest rate (EIR)

= (loan * Annual interest on loan) : (Loan - Required compensating balance)

= ($2,000,000 * 9%) : ($2,000,000 - $100,000)

= ($2,000,000 * 0.09) : ($1,900,000)

= 0.0947 ≈ 0.095

or

= 0.095 * 100%

= 9.5%

Hence,

the answer is option (b) 9.5%