Explanation:
The marginal cost rate represents the cost of raising additional funds, considering both the explicit cost of new funds and the implicit cost of having to pay higher rates on existing funds.
Given:
$100 million at 2%$50 millionCalculation:
Additional interest cost on existing deposits:
$100 million × 2% = $2 million$100 million × 3% = $3 million$3 million - $2 million = $1 millionInterest cost on new deposits:
$50 million × 3% = $1.5 millionTotal additional cost:
$1 million$1.5 million$2.5 millionMarginal cost rate:
$2.5 million ÷ $50 million = 5%Therefore, the marginal cost rate is 5%, which corresponds to option B.
This calculation shows that while the bank is paying 3% explicitly on the new $50 million, it also incurs an additional 1% cost on the existing $100 million, effectively increasing the true marginal cost to 5%.
Ultimate access to all questions.
A bank currently has $100 million of deposits earning an average rate of 2%. It would like to raise an additional $50 million, but to do so, will have to raise the deposit rate to 3% on both the old and new accounts. What is the marginal cost rate of the additional $50 million in funds?
A
3%.
B
5%.
C
7%.
D
9%.
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