Choice "C" is correct. The effective rate of interest rate is 10%. The effective interest rate represents the actual finance charges associated with a borrowing after reducing loan proceeds for charges and fees. The above scenario indicates that finance charges are $40,000 ($500,000 x 8%), and the net proceeds or amount available under the loan is $400,000 (the face value of $500,000 net of the 20% compensating balance of $100,000 [$500,000 x 20%]). The effective rate of interest is the finance charge of $40,000 divided by the net proceeds of $400,000:

Choice "d" is incorrect. The stated rate of the loan (8%) is not the effective rate of interest.
Choice "a" is incorrect. The compensating balance (20%) percentage is not the effective rate of interest.
Choice "b" is incorrect. The sum of the stated rate and the compensating balance (28%) is not the effective rate of interest.