A. In a loan with a compensating balance the borrower does not actually receive all of the monies that are loaned because they must keep on deposit with the bank some of the money as the compensating balance. However, they must pay interest on the full amount of the loan. Therefore, Hagar will pay $7,000 in interest, but receive only $80,000. This makes the effective interest rate 8.75% ($7,000 / $80,000).
B. In a loan with a compensating balance the borrower does not actually receive all of the monies that are loaned because they must keep on deposit with the bank some of the money as the compensating balance. However, they must pay interest on the full amount of the loan. Because of this the effective interest rate on the loan is higher than the stated (or nominal) rate of the loan. See the correct answer for a complete explanation.
C. In a loan with a compensating balance the borrower does not actually receive all of the monies that are loaned because they must keep on deposit with the bank some of the money as the compensating balance. However, they must pay interest on the full amount of the loan. Because of this the effective interest rate on the loan is higher than the stated (or nominal) rate of the loan. See the correct answer for a complete explanation.
D. This answer is incorrect. See the correct answer for a complete explanation.
