Line of credit - Compensating Balance

Excel File


You’ve worked out a line of credit arrangement that allows you to borrow up to $40 million at any time.
The interest rate is .56 percent per month.
 In addition, 4 percent of the amount that you borrow must be deposited in a noninterest-bearing account.
Assume that your bank uses compound interest on its line of credit loans.

Facts
Credit Max 40,000,000
Interest 0.0056 monthly
Compensating% 0.04
Compound

a. What is the effective annual interest rate on this lending arrangement?
(Solve for full loan) 12 Months

Compensating balance 1,600,000 Credit max x Compensating%
PV Amt borrowed 38,400,000
Repayment Amt 42,772,355.47 Credit Max x (1 + Interest)^12
FV Cash Flow 41,172,355.47 Put the compensating balance back in at the end of the year

FV = PV(1+R) Base interest rate on Amt Borrowed

41,172,355.47 = 38,400,000 x 1 + r
1.072196757 = 1 + r
0.072196757 = r

r= 7.22%

b. Suppose you need $20 million today and you repay it in 6 months. How much interest will you pay?

Credit Max 40,000,000
Interest 0.0056 monthly
Compensating% 0.04
Compound

Term 6
Amount Required 20,000,000
Amt to Borrow 20,833,333 (Amount required / (1+compensating%)
Compensating balance 833,333 Credit max x Compensating%
Amt borrowed 20,833,333

Interest 709,873.48 (Amount Borrowed x (1+Interest)^Months) - Amount Borrowed