The effective annual rate (rEAR) it pays on a loan is lower whenever a firm must use some of the proceeds from the loan to meet the bank's compensating balance requirement.
Answer the following statement true (T) or false (F)
False
A compensating balance is a minimum checking account balance that a firm must maintain with a bank to borrow funds, it is generally 10 to 20 percent of the amount of loans outstanding. When compensating balances prevent the borrower from using the entire amount of the loan, the effective annual rate paid for the loan is higher than the stated interest rate. See 14-5: Computing the Cost of Short-Term Credit
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