Question

Bank USA recently purchased $11.3 million worth of euro-denominated one-year CDs that pay 11 percent interest annually. The current spot rate of U.S. dollars for euros is $1.104/€1.
a. Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro?
b. What will be the return on the one-year CD if the dollar appreciates relative to the euro such that the spot rate of U.S. dollars for euros at the end of the year is $1.004/€1? (Round your answer to 3 decimal places. (e.g., 32.161))
c. What will be the return on the one-year CD if the dollar depreciates relative to the euro such that the spot rate of U.S. dollars for euros at the end of the year is $1.204/€1? (Round your answer to 3 decimal places. (e.g., 32.161)

	a. Exposure b. Return if dollar appreciates % c. Return if dollar depreciates %

Answer 1

a. Bank USA is exposed to a appreciation of the dollar relative to the euro.

current value of euro-denominated one-year CDs is $11,300,000/$1.104/€1 = €10,235,507

Interest on euro-denominated one-year CDs = €10,235,507*11% = €1,125,905.77

Interest will be received in Euros because it's a euro-denominated CD. at current rate of $1.104/€1, dollar amount of interest is €1,125,905.77*$1.104/€1 = $1,242,999.97. suppose after one year dollar appreciates to $1.101/€1 then dollar amount of interest will be €1,125,905.77*$1.101/€1 = $1,239,622.25. so Bank USA is exposed to a appreciation of the dollar relative to the euro.

b. value of interest in dollars at one-year spot rate = €1,125,905.77*$1.004/€1 = $1,130,409.39

Return if dollar appreciates = $1,130,409.39/$11,300,000 = 0.10004 or 10.004%

c. value of interest in dollars at one-year spot rate = €1,125,905.77*$1.204/€1 = $1,355,590.55

Return if dollar depreciates = $1,355,590.55/$11,300,000 = 0.11996 or 11.996%