North Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year $2 million CD at 6 percent and funded a loan in euros at 8 percent. The spot rate for the euro was €1.45/$ at the time of the transaction (US being the home country). Information received immediately after the transaction closing indicated that the euro will depreciate to €1.47/$ by year-end. If the information is correct, what will be the realized spread on the loan? What should have been the bank interest rate on the loan to maintain the 2 percent spread? Assume adjustments in principal value are included in the spread. The bank had an opportunity to sell one-year forward marks at €1.46. What would have been the spread on the loan if the bank had hedged forward its foreign exchange exposure? What is interest rate parity theory and calculate that at what forward exchange rate of dollars per euro, an investor in USA would earn the same interest rate on investing either in USA or Europe?
North Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year $2 million CD at 6 percent and funded a loan in euros at 8 percent. The spot rate for the euro was €1.45/$ at the time of the transaction (US being the home country). Information received immediately after the transaction closing indicated that the euro will depreciate to €1.47/$ by year-end. If the information is correct, what will be the realized spread on the loan? What should have been the bank interest rate on the loan to maintain the 2 percent spread? Assume adjustments in principal value are included in the spread. The bank had an opportunity to sell one-year forward marks at €1.46. What would have been the spread on the loan if the bank had hedged forward its foreign exchange exposure? What is interest rate parity theory and calculate that at what forward exchange rate of dollars per euro, an investor in USA would earn the same interest rate on investing either in USA or Europe?
Chapter7: International Arbitrage And Interest Rate Parity
Section: Chapter Questions
Problem 35QA
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North Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year $2 million CD at 6 percent and funded a loan in euros at 8 percent. The spot rate for the euro was €1.45/$ at the time of the transaction (US being the home country).
- Information received immediately after the transaction closing indicated that the euro will
depreciate to €1.47/$ by year-end. If the information is correct, what will be the realized spread on the loan? What should have been the bank interest rate on the loan to maintain the 2 percent spread? Assume adjustments in principal value are included in the spread. - The bank had an opportunity to sell one-year forward marks at €1.46. What would have been the spread on the loan if the bank had hedged forward its foreign exchange exposure?
- What is interest rate parity theory and calculate that at what forward exchange rate of dollars per euro, an investor in USA would earn the same interest rate on investing either in USA or Europe?
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