Effective Interest Rate Calculations for Loans

A short-term obligation that matures within one year or less. Often used to finance current assets and manage temporary fluctuations in funds.

Funding that comes from within the business itself, generated from normal operations.

Short-term financing obtained from external sources, such as banks.

A type of unsecured short-term loan from a bank, offering a pre-approved credit limit to draw upon.

A single-payment loan obtained from a bank for a short period.

A type of short-term bank loan that is unsecured, meaning it doesn't require collateral.

The cost of borrowing money or securing financing.

The true cost of borrowing, taking into account factors like compounding and fees.

A guaranteed line of credit where the bank commits to providing a specific amount of funds. There's a fee charged on the unused portion of the credit, even if you don't borrow the full amount.

Similar to revolving credit, but for consumers. Credit card companies, stores, and banks offer these lines of credit up to a limit. Interest is charged monthly on the outstanding balance, compounding the interest and leading to higher effective rates.

A formal agreement between a borrower and a bank which details the terms of a revolving credit agreement.

A short-term loan provided by banks to cover temporary financial shortfalls for current account holders. Interest is charged daily and a penalty is applied if the borrower doesn't pay at the end of the term.

The document signed by the borrower that outlines the terms of a short-term unsecured loan.

A financial strategy where companies use their accounts receivables as collateral to secure loans. The lender assesses the creditworthiness of the debtors before offering the loan.

A type of account receivable factoring where the company pledges its receivables as collateral for a loan, but retains ownership of the receivables.

A type of account receivable factoring where the company sells its receivables to a factoring company (known as a factor) for immediate cash.

A financial strategy where companies use their inventory as collateral to secure loans. The loan may be obtained through trust receipts, warehouse receipts, floating liens, or a combination of these methods.

A type of inventory financing where the company holds the inventory for the lender, and any proceeds from the sale of the inventory must be forwarded to the lender.

A type of inventory financing where the inventory is stored in a bonded warehouse, and the lender releases the inventory only when authorized by the borrower.

A type of inventory financing where the lender has a security interest on the firm's entire inventory, including present and future inventory.

A type of inventory financing where the inventory is stored in the firm's own warehouse and separated from other inventories. Only the lender has the authority to release the inventory.

The interest rate that accurately reflects the true cost of borrowing, taking into account the time value of money.

A calculation to determine the effective cost of borrowing when interest is deducted upfront, decreasing the net proceeds available to the borrower.

A requirement for borrowers to maintain a specific amount of funds in an account at the lending bank, even if they don't actively use it.

The amount the borrower actually receives after deducting any upfront interest or fees.

The total interest paid over the entire borrowing period, regardless of whether it's simple or compound interest.

To calculate the EIR, you need to consider the net proceeds and the total interest paid over the loan's duration.

The length of time for which a loan is taken out, usually expressed in months.

The higher the total interest paid, the higher the EIR will be, reflecting a higher cost of borrowing.

The interest earned on an investment, calculated as the difference between the face value and the purchase price.

The amount of money a borrower receives after deducting fees from the total loan amount.

The cost charged by the bank for the unused portion of the revolving credit line.

A fee charged for placing a commercial paper issue in the market.

Discounted interest refers to a practice where the interest is calculated on the face value of a loan or investment, but the borrower receives the principal less the interest. This upfront deduction effectively increases the actual interest rate.

The EIR for a revolving credit facility considers interest charges, commitment fees, and potential compensating balances. It can be calculated by dividing the total cost of using the credit facility (interest and fees) by the net amount of funds received.

EIR for commercial paper involves factoring in the discounted interest (where interest is deducted upfront), the issuer's costs, and the maturity period. It reflects the real return earned by investors after accounting for these costs.

The calculation of EIR involves dividing the total cost of financing by the amount of usable funds borrowed. It allows for a clear understanding of the true cost of borrowing, aiding in comparing different financing options.

EIR is crucial for effective financial decision-making. By considering the true cost of borrowing, businesses can make informed choices regarding their funding options. It helps evaluate the efficiency and optimize financing strategies.