Choi, Youngna and Yoon, Yeomin (2004) Compensating Balance: A Comment. International Journal of Banking and Finance (IIJBF), 2. pp. 83-98. ISSN 1675-7227

PDF Restricted to Registered users only Download (1MB)

Abstract

Compensating balance are deposits the borrowing firm keeps with the lending bank in non-interest bearing accounts on loans.It is well known that, when there is no compensating balance imposed, the effective cost of debt remains the same in the two different payment methods, full amortization method and bullet loan (bond) method.It has been experimentally shown that when a compensating balance is imposed, however, the respective effective costs of debt under the two payment methods become different and that the true cost of a fully-amortized loan is always greater than that of a bullet loan. This paper provides a mathematical proof than this is always true.It concludes that, whenever a bank imposes a compensating balance, the borrowing firm should prefer a bullet loan to a fully-amortized one if it wishes to avoid an ambush posed by such a compensating balance.

Item Type:	Article
Uncontrolled Keywords:	Compensating balance, effective cost of debt, net present value, amortization, bullet payment method
Subjects:	H Social Sciences > HG Finance
Divisions:	School of Economics, Finance & Banking
Depositing User:	Mrs. Norazmilah Yaakub
Date Deposited:	01 Nov 2018 01:27
Last Modified:	01 Nov 2018 01:27
URI:	https://repo.uum.edu.my/id/eprint/25117

Actions (login required)

View Item