Compensating Balance MCQs

If a company needs $220,000 in funds and the bank requires a 20% compensating balance, how much must the company borrow?

• $275,000

• $220,000

• $200,000

• $250,000

Answer explanation

Amount to be borrowed = Amount needed / (1 - Compensating Balance Rate) 

= $220,000 / (1 - 0.20) = $275,000 

A company borrows $100,000 at an annual interest rate of 10%. The bank requires a 15% compensating balance. What is the effective interest rate?

• 10%

• 11.76%

• 9.5%

• 12%

Answer explanation

Effective rate = Interest rate / (1 - Compensating Balance Rate) 

= 10% / (1 - 0.15) = 11.76% 

A company requires $500,000 in funds and the bank demands a 25% compensating balance. How much must the company borrow?

• $625,000

• $500,000

• $450,000

• $550,000

Answer explanation

Amount to be borrowed = Amount needed / (1 - Compensating Balance Rate) 

= $500,000 / (1 - 0.25) = $625,000 

A company borrows $1,000,000 from the bank at 8% interest. The bank requires a 10% compensating balance. What is the effective interest rate?

• 8%

• 8.89%

• 9%

• 10%

Answer explanation

Effective rate = Interest rate / (1 - Compensating Balance Rate) 

= 8% / (1 - 0.10) = 8.89% 

If a company borrows $200,000 from the bank at 5% interest and must maintain a 20% compensating balance, what is the amount of the compensating balance?

• $40,000

• $250,000

• $210,526

• $10,000

Answer explanation

Compensating balance = Loan Amount x Compensating Balance Rate 

= $200,000 x 20% = $40,000 

A company borrows $150,000 at an interest rate of 12% per year. The bank requires a 25% compensating balance. What is the effective interest rate?

• 16%

• 15%

• 18%

• 14%

Answer explanation

Effective rate = 12% / (1 - 0.25) = 16%