Question

A British bank issues a $160 million, three-year Eurodollar CD at a fixed annual rate of 5 percent. The proceeds of the CD are lent to a British company for three years at a fixed rate of 7 percent. The spot exchange rate of pounds for U.S. dollars is £1.50/US$.

a-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

Please show work if you can.

Answer 1

Please see the tables below. Explanation has been provided for each entry in the table itself.

Part a - 2

Please see the table below.

Equivalent loan in pounds = Dollar loan x exchange rate = $ 160 mn x 1.50.

The cash inflow will be the interest of 7% on this amount.

Nature	Eurodollar CD			British Loan
	Cash Outflow (U.S.$)	(£)	Cash Inflow (£)	Spread (£)
	A	B = A x Exchange rate	C	D = C - D
Interest = Principal x Interest rate	160 x 5% = 8.00	$ 8 x 1.50 = 12.00	150 x 1.50 x 7% = 16.80	16.80 – 8.00 = 4.80
Same as above	160 x 5% = 8.00	$ 8 x 1.50 = 12.00	150 x 1.50 x 7% = 16.80	4.80
Interest + Principal repayment	160 + 160 x 5% = 168.00	$ 168 x 1.50 = 252.00	150 x 1.50 x (1 + 7%) = 256.80	4.80

Part b

Nature	Eurodollar CD			British Loan
	Cash Outflow (U.S.$)	(£)	Cash Inflow (£)	Spread (£)
	A	B = A x Exchange rate	C	D = C - D
Interest = Principal x Interest rate	160 x 5% = 8.00	$ 8 x 1.65 = 13.20	150 x 1.50 x 7% = 16.80	16.80 – 13.20 = 3.60
Same as above	160 x 5% = 8.00	$ 8 x 1.815 = 14.52	16.80	16.80 - 14.52 = 2.28
Interest + Principal repayment	160 + 160 x 5% = 168.00	$ 168 x 2.00 = 336.00	256.80	256.80 - 336.00 = -79.20

Part (c)

t	Cash Flow (£)	Swap Payments (£)	Net Swap Cash flow (£)	Total Cash Flow (£)
	Column B of part (b)	Column A of part (a)
	A	B	C = A - B	D = C + last column of part (b)
1	13.20	12.00	1.20	4.80
2	14.52	12.00	2.52	4.80
3	336.00	252.00	84.00	4.80