Chapter 16, Problem 8Q

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# Define each of the following loan terms, and explain how they are related to one another: the prime rate, the rate on commercial paper, the simple interest rate on a bank loan calling for interest to be paid monthly, and the rate on an installment loan based on add-on interest. If the stated rate on each of these loans was 5%, would they all have equal, effective annual rates? Explain.

Summary Introduction

To explain: The meaning of given loan terms and their relationship with each other. The effective annual rate for each given term.

Introduction:

Interest Rate:

It indicates that percentage which is applicable to all investments and loans for determination of amount of interest related to a specific period.

Loan:

It refer to that quantitative value of currency which is borrowed from any financial institution (outside source) to fulfill the required funds for operations. There are different types of loan that are available on basis of the requirements.

Explanation

Prime rate:

It indicates the percentage of interest which is applicable by the commercial banks to borrowers with large amounts.

Rate on commercial paper:

It indicates the percentage of interest which is applicable only on such debts which are unsecured and short-term in nature.

Simple interest:

It refers to the percentage of interest which is applied on monthly basis on principal amount.

It refers to the method of interest determination in which the amount of interest is initially calculated on the loan and then added in the installments to keep the amount of each installment same during the whole process of payment.

Relation between prime rate, rate on commercial paper, and simple interest:

• The above mentioned terms are types of interest determination method...

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