Certified Management Accountant Practice Exam 2025 - Free CMA Practice Questions and Study Guide

The effective rate with compensating balances can be accurately calculated by adjusting the stated interest rate based on the percentage of the compensating balance that is not available for use. When a loan has a compensating balance requirement, it means that a certain percentage of the loan amount must be kept in a non-interest-bearing account. This reduces the amount of funds that are actually usable or available from the loan.

In this context, the formula uses the stated rate divided by the difference between one and the compensating balance percentage. This gives a clearer picture of the effective interest rate, as it accounts for the reduced usable funds due to the required compensating balance. By using the stated rate divided by (1.0 - compensating balance %), you demonstrate how much interest is effectively paid on the funds that can actually be used, highlighting that the effective interest rate is increased due to the presence of compensating balances.

Understanding this concept is essential for analyzing loan costs and evaluating the true expense associated with borrowing when compensating balances are involved. Therefore, the calculation reflects the reality of financial transactions where access to loan funds is restricted, impacting the overall cost of borrowing.