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**CFA Practice Question**

A firm sells commercial paper of face value $1,000,000 for 2 months. The quoted rate on the paper is 5.43%. The backup line cost is 0.20% and the dealer's commission is 0.09 percent, both of which are assessed on face value. The effective cost of financing for the firm is:

A. 7.316%

B. 7.235%

C. 6.198%

**Explanation:**Costs = (5.43% * (2 months/12 months) + 0.20% + 0.09%) * 1,000,000 = 11,950 (remember that the interest costs are annualized, whereas the duration of the CP is only 2 months)

The proceeds from the sale are: $1,000,000 * (1 - 5.43% * (2 months/12 months)) = 990,950

Therefore Commercial Paper (CP) cost = (12/2) * 11,950 / 990,950 = 7.235%

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**User Contributed Comments**
2

User |
Comment |
---|---|

Sandar |
isn't that diffferent from the textbook calculation ..both based on the same face value.. |

michaeloa3 |
Yeah, threw me off, it is different, textbook, treats backup line cost and dealer commission as calculated as percentages over only 2 months |