can anyone help me with this accounting problem?

Question

A bank lends a firm $1,000,000 for one year at 12 percent on a discounted basis and requires compensating balances of 10 percent of the face value of the loan. What is the effective annual interest rate associated with this loan?

Answer 1

12%

The rate paid on the loan is 12% (assuming simple interest rather than compounding). The compensating balance is just cash kept as a deposit, which the company gets back. This doesn't affect the interest on the loan - just opportunity cost.

Answer 2

32% APR