Certified Management Accountant Practice Exam

Question: 1 / 430

What happens to the effective rate as the stated rate of a discounted loan increases?

The effective rate decreases.

The effective rate remains the same.

The effective rate increases.

As the stated rate of a discounted loan increases, the effective rate also increases. This occurs because the effective rate takes into account the actual cost of borrowing over the life of the loan, which includes how the interest is applied based on the stated rate.

In a discounted loan, the interest is deducted upfront from the loan amount, meaning the borrower receives less than the face value of the loan. Consequently, as the stated rate rises, the amount deducted for interest also increases, leading to a higher effective interest cost relative to the amount actually received.

This relationship highlights the importance of understanding both the stated rate and the effective rate when evaluating loan agreements. A higher stated rate indicates that the borrower will be paying more in interest, ultimately increasing the effective rate of borrowing.

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The effective rate becomes irrelevant.

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