Asked by Quinn Duncan on May 05, 2024
Verified
Which of the following is true of compensating balances?
A) Compensating balances increase the effective cost of a loan.
B) Compensating balances allow firms to convert their receivables into cash quickly.
C) Only a small percentage of businesses can issue compensating balances.
D) Most compensating balances are unsecured.
Compensating Balances
Minimum balance requirements mandated by banks for borrowers, serving as a form of security for the loan.
Effective Cost
Effective Cost is the total cost of a product or service once all relevant factors, including hidden costs and indirect expenses, are considered.
Loan
is a sum of money borrowed that is expected to be paid back with interest.
- Understand the concept of compensating balances and their effect on the cost of borrowing.
Verified Answer
ZS
Zainab SaeedMay 11, 2024
Final Answer :
A
Explanation :
Compensating balances are funds that a borrower must keep in a bank account as a condition of a loan, effectively reducing the amount of usable funds from the loan and increasing the effective interest rate or cost of the loan. They do not directly relate to converting receivables into cash, are not limited to a small percentage of businesses, and are not about the security of the loan but rather a requirement by the lender.
Learning Objectives
- Understand the concept of compensating balances and their effect on the cost of borrowing.