Question

North Bank has been borrowing in the U.S. markets and lending abroad, thereby incurring foreign exchange risk. In a recent transaction, it issued a one-year $2.25 million CD at 4 percent and is planning to fund a loan in British pounds at 6 percent for a 2 percent expected spread. The spot rate of U.S. dollars for British pounds is $1.4500/£1. a. However, new information now indicates that the British pound will appreciate such that the spot rate of U.S. dollars for British pounds is $1.4300/£1 by year-end. Calculate the loan rate to maintain the 2 percent spread? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Loan rate 0.55 % b. The bank has an opportunity to hedge using one-year forward contracts at 1.4600 U.S. dollars for British pounds. Calculate the net interest margin if the bank hedges its forward foreign exchange exposure? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Net interest margin % c. Calculate the loan rate to maintain the 2 percent spread if the bank intends to hedge its exposure using the forward rates? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Loan rate %

Answer 1

Answer to question 1.

Loan rate to maintain 2% spread :

Amount of loan = 2.25 million * 1.45

= 3.26

Interest and principal at year end : 3.26*1.06 = 3.46 Million/1.4300

= $2419580. 42   

Interest and principal of CD : 2.25Million * 1.04 = $2340000

Net Interest Income : $2419580.42 - 2340000

= $79580.42

Net Interest margin = $79580.42/2.25Million

= 3.54%

To maintain 2% Spread interest and prinicpal earned at 1.43 $ should be :(2.39 - 2.34)/2.25 = 2%)

3.26(1+X)/1.43 =2.39

1+x = 2.39*1.43/3.26

= 1.04837

x = .04837 or 4.84%

Interest rate on Loan should be 4.84%

Question 2

Net Interest Margin if bank hedges its forward exchange exposure

Net Interest Income if Hedged : 3.26*1.06 = 3.46/1.46

= $2.37 m - 2.34m

= 0.03m /30000million

Net Interest Margin : $0.03/$2.25 = 1.33%

Question 3

Loan rate to maintain 2% spread to hedge the exposure

To maintain 2% spread : 3.26(1+x)/1.46 = 2.39

1+x = 2.39*1.46/3.26

   1.070

X = 7.03%