Ace the CMA 2025 Challenge – Unlock Your Accounting Superpowers!

The effective rate on a discounted loan reflects the true cost of borrowing, taking into account how much funding the borrower actually receives after accounting for fees or discounted amounts. The formula for calculating the effective rate is best represented by the relationship between net interest expense and the usable funds obtained from the loan.

In this context, net interest expense refers to the total cost of borrowing, which includes the interest that would be paid on the entire loan amount. Usable funds are the actual amount that the borrower has access to after any discounts or deductions are applied, which directly impacts the effective cost.

When calculating the effective rate, it essentially measures how much interest expense is incurred relative to the amount of funds that the borrower can actually use. Thus, dividing the net interest expense by the usable funds gives a clear perspective on the true economic burden of the loan, allowing for a more accurate assessment of its cost over time.

Therefore, this relationship accurately captures the effective rate on a discounted loan by emphasizing the significance of net interest expense in conjunction with usable funds, leading to a clear understanding of the cost of borrowing in practical terms.