Example 142

Assume that a company borrows $20,000 at 10 percent. Calculate the effective interest cost if the loan requires a minimum compensating balance of 20 percent ($4,000) and it is on a discount basis.

The effective interest cost of the loan is:

Currency movement and interest rates In reality, the value of the currency borrowed will change with respect to the borrower's local currency over time. The actual cost of a bank credit by the borrower depends on the interest rate charged by the bank and the movement in the borrowed currency's value over the life of the loan. Thus, the effective interest rate may differ from the interest rate that we computed in examples 14.1 and 14.2. In this case, the effective interest rate is computed as follows:

where r is the effective interest rate in US dollar terms, if is the interest rate of the foreign currency, and ie is the percentage change in the foreign currency against the US dollar.

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