Answer (D) is correct . The effective interest rate on a loan with a compensating balance can be calculated as follows: Effective rate = Stated rate ÷ (1.0 – Compensating balance %) = 7% ÷ (100% – 20%) = 7% ÷ 80% = 8.75% Note that the amount of the loan is not needed to calculate the effective rate.
Answer (A) is incorrect because The borrower has access to less, not more, than the face amount of the loan.
Answer (B) is incorrect because The effective rate is higher than the contract rate as a result of the compensating balance requirement.
Answer (C) is incorrect because This percentage is 120% of the contract rate.
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