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Part 1

Compensating balance versus discount loan Weathers Catering Supply, Inc., needs to borrow $148,000 for 6 months. State Bank has offered to lend the funds at an annual rate of 8.8% subject to a 10.4% compensating balance.(Note:Weathers currently maintains $0 on deposit in State Bank.) Frost Finance Co. has offered to lend the funds at an annual rate of 8.8% with discount-loan terms. The principal of both loans would be payable at maturity as a single sum.

a.Calculate the effective annual rate of interest on each loan.

b.What could Weathers do that would reduce the effective annual rate on the State Bank loan?