You friend, Edwin Slotkin, has started a new business, but has recently encountered a slight cash flow problem. He obtains a $1,000 loan at 10% per year from a local bank, but would like to ask you about the terms. The bank has deducted the interest in advance and he wants to know if 10% is his effective interest rate. How would you respond in an email?
Hello Edwin:
Good to hear from you!
Regarding your question, the "real" rate or effective rate of interest is not 10%. This rate can be calculated as $100 interest divided by your proceeds of $900, or approximately 11.11%. The rate is calculated on the basis of the amount that your company actually obtained, rather than the face amount of the note. This is sometimes referred to as discounting a note. The interest rate on a discounted note is always higher than it appears.
I hope your business is on the upswing. Let me know if you have any other questions.
Your friend,
(student)
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