Discount interest loan with a 10% compensating

balance

• Interest = 0.08 ($121,951) = $9,756

• Effective cost = $9,756 / $100,000 = 9.756%
Add-on interest on a 12-month installment loan

• Interest = 0.08 ($100,000) = $8,000

• Face amount = $100,000 + $8,000 = $108,000
• Monthly payment = $108,000/12 = $9,000
• Avg loan outstanding = $100,000/2 = $50,000
• Approximate cost = $8,000/$50,000 = 16.0%
• To find the appropriate effective rate, recognize that the
firm receives $100,000 and must make monthly
payments of $9,000. This constitutes an annuity.
Installment loan
From the calculator output below, we have:

kNOM = 12 (0.012043)
= 0.1445 = 14.45%

EAR = (1.012043)12 – 1 = 15.45%

INPUTS 12 100 -9 0
N I/YR PV PMT FV
OUTPUT 1.2043
What is a secured loan?

• In a secured loan, the borrower pledges assets

as collateral for the loan.
• For short-term loans, the most commonly
pledged assets are receivables and inventories.
• Securities are great collateral, but generally not
available.