Question

A British bank issues a $220 million, three-year Eurodollar CD at a fixed annual rate of 5 percent. The proceeds of the CD are lent to a British company for three years at a fixed rate of 7 percent. The spot exchange rate of pounds for U.S. dollars is £1.50/US$.

a-1. Is this expected to be a profitable transaction ex ante?

Yes
No

a-2.

What are the cash flows if exchange rates are unchanged over the next three years? (Do not round intermediate calculations. Enter your answers in millions rounded to 2 decimal places. (e.g., 32.16))

Eurodollar CD

British Loan

  t Cash Outflow (U.S.$) (£) Cash Inflow (£) Spread (£)
  1 million million million million
  2 million million million million
  3 million million million million

  b.

If the U.S. dollar is expected to appreciate against the pound to £1.65/$1, £1.815/$1, and £2.00/$1 over the next three years, respectively, what will be the cash flows on this transaction? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers in millions rounded to 2 decimal places. (e.g., 32.16))

Eurodollar CD

British Loan

  t Cash Outflow (U.S.$) (£) Cash Inflow (£) Spread (£)
  1 million million million million
  2 million million million million
  3 million million million million

  c.

If the British bank swaps U.S. dollar payments for British pound payments at the current spot exchange rate, what are the cash flows on the swap and on the entire hedged position? Assume that the U.S. dollar appreciates at the same rates as in part (b). (Do not round intermediate calculations. Enter your answers in millions rounded to 2 decimal places.(e.g., 32.16))

  t Cash Flow
(£) Swap Payments
(£) Net Swap
Cash Flow
(£) Total Cash Flow (£)
  1 million million million million
  2 million million million million
  3 million million million million

Answer 1