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August 30, 2015

Homework Help: Business finance

Posted by Bryan on Monday, January 10, 2011 at 9:15pm.

In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $10,000 and the interest rate is 10 percent, the borrower “pays” 0.10 x $10,000 = $1,000 immediately, thereby receiving net funds of $9,000 and repaying $10,000 in a year.

a. What is the effective interest rate on this loan?
b. If you call the discount d (for example, d= 10% using our numbers), express the effective annual rate on the loan as a function of d.
c. Why is the effective annual rate always greater than the stated rate d?

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