[kukuna2008]

I am quite confused on how compensate balance affect the effective interest rate. there are two questions in Ninja book, page 44 and 83, of which the calculations are quite different. On page 44, is use the real balance as in the cash account (25K) rather than the required balance( 50k) to calculate the interest rate. however, on page 83, similar situation , it use the required balance (40 k), rather than real cash balance (0), to calculate the interest. So which one is correct?

thank you!

FAR - 83, 04/2015
AUD - 73, 86, 08/2015
REG - 75
BEC - 71, rematch in 04/2016

[Biff-1955-Tannen]

I don't have the Ninja books so I can't see the exact calculations, but I can try to explain the compensating balances and see if that helps. When you're finding the effective interest rate or the cost of capital, you want the denominator to equal how much money you are actually going to be benefiting from. So if you're taking a loan of 100k but it requires a compensating balance of 20k, you're only receiving the benefit from 80k because the 20k compensating balance is something you can't really use. Now I know there is a question in Ninja MCQ that says something like, you receive a loan of 150k but it requires a compensating balance of 50k. If you already normally have 25k in the account, now you only need to take 25k from your 150k loan to have the 50k compensating balance. So the denominator will be 125k, instead of 100k.
And if the question states that the account that the compensating balance is in earns x amount of interest anum, then the interest earned from the additional cash (that is in the account solely because of the loan) will help offset the interest paid on the new loan (so you will reduce the numerator by that amount)
Hopefully this will help clear things up…

AUD - 93
BEC - 83
FAR - 83
REG - 84

Nobody calls me chicken

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[kukuna2008]

Biff-1955-Tannen, thank you for your answer very much! I think you solved my confusion. I guess I misunderstood about the 25 k balance situation. now i went back to read the problem again, I think it does mean there was 25k in the account for transaction purpose. it is a word game to me! thank you so much !

FAR - 83, 04/2015
AUD - 73, 86, 08/2015
REG - 75
BEC - 71, rematch in 04/2016

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