Answer (D) is correct . The effective interest rate on a discounted loan can be calculated as follows: Effective rate = Stated rate ÷ (1.0 – Stated rate) = 10% ÷ (100% – 10%) = 10% ÷ 90% = 11.11% Note that the amount of the loan is not needed to calculate the effective rate.
Answer (A) is incorrect because The prepayment of interest reduces the funds available, resulting in an effective interest rate greater than the contract rate.
Answer (B) is incorrect because The prepayment of interest reduces the funds available, resulting in an effective interest rate greater than the contract rate.
Answer (C) is incorrect because This percentage is the contract rate. The effective rate is higher because the full $2 million face amount of the note will not be available to the borrower.
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