## Compensating Balance:

A compensating balance is the amount of fund that must be remained at a non-interest bearing account. For a loan with a compensating balance, the amount of fund available to the borrower is effectively reduced.

We can use the following formula to compute the effective rate of interest:

• effective rate of interest = stated interest rate / (1 - compensating balance)
• effective rate of interest = 14% / (1 - 27%)
• effective rate of interest = 19.18%