Question

Bank USA recently purchased $11.7 million worth of euro-denominated one-year CDs that pay 10 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	Appreciation
b.	Return if dollar appreciates		%
c.	Return if dollar depreciates		%

Answer 1

a	The company has investment $ 11.7 million in dollar terms but when converted into Euro using spot exchange rate, the investment is worth $ 11700000/1.104 = Euro 10597826. Therefore, Bank USA is exposed to appreciation of dollar relative to Euro
b	Bank USA has purchased Euro denominated CDs of $ 11.7 million since the CDs are Euro denominated, the investment has been done in Euro based on the spot rate of investment
	Spot Rate	$1.104/Euro 1
		1 Euro = $1.104
	Therefore $ 11.7 million or $11700000/1.104 = 10597826 Euros
	At the end of One year, Bank USA would get principal and interest in Euro which will be converted into dollars based on the rate available at the end of one year
	Interest earned in one year			Euro 10597826*10%			1059782.60
	Money which will be received at the end of one year = Principal + Interest
						10597826+1059782.60
					Euros	11657608.60
	Exchange rate is		1 Euro = $ 1.004
	Therefore, investment in dollar terms is 11657609*1.004						11657608.60*1.004
							11704239
	Return on investment = ($11704239-$11700000)/$11700000						0.036%
	Therefore, return on investment when exchange rate is $1.004/Euro 1 is 0.036%
c	Investment in Euros made by Bank USA = $11700000/1.104						10597826.1	Euros
	At the end of oner year, Bank USA would receive Principal and interest payment at spot rate of $ 1.204/Euro 1
	Interest earned in Euro			10597826*10%		1059782.6
	Total money received in Euro = 10597826+1059782.60						11657608.60	Euros
	Money Received when converted into dollars is 11657608.80*1.204						Dollars	14035761
	Return on investment = (14035761-11700000)/11700000						19.964%
	Return on investment when rate is $1.204/Euro 1 is 19.964%
a	Exposure		Appreciation	Euro 10597826.10
b	Return if dollar appreciates		0.036%
c	Return if dollar depreciates		19.96%