(Calculating the cost of short-term financing)

You plan to borrow $40,000 from the bank to pay for inventories for a gift shop you have just opened. The bank offers to lend you the money at 10 percent annual interest for the 3 months the funds will be needed (assume a 360-day year).

a. Calculate the annualized rate of interest on the loan.

b. In addition, the bank requires you to maintain a 14 percent compensating balance in the bank. Because you are just opening your business, you do not have a demand deposit account at the bank that can be used to meet the compensating-balance requirement. This means that you will have to put 14 percent of the loan amount (which you had planned to use to help finance the business) in a checking account. What is the cost of the loan now?

c. In addition to the compensating-balance requirement in part b. you are told that interest will be discounted. What is the annualized rate of interest on the loan now?