When a loan is discounted, the bank withholds the amount of the interest from the proceeds that are loaned. But when the loan becomes due the borrower needs to repay the full face amount of the loan. In this loan, the interest is $25,000. This is withheld from the proceeds of the loan and Frame will receive only $100,000. The amount they will need to repay is $125,000, which includes $25,000 in interest. Given the proceeds of $100,000, the effective interest rate is 25%.
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This is the nominal rate of interest. When there is discounted interest the effective rate of interest is higher than the nominal rate of interest, so this answer is not possible. When a loan is discounted, the bank withholds the amount of the interest from the proceeds that are loaned. But when the loan becomes due the borrower needs to repay the full face amount of the loan. The difference is the interest. The effective annual rate is the interest paid for one year divided by the net proceeds of the loan that is outstanding during the year.
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