A bank purchases a six-month $4 million Eurodollar deposit at an interest rate of 7.6 percent...

A bank purchases a six-month $4 million Eurodollar deposit at an interest rate of 7.6 percent per year. It invests the funds in a six-month Swedish krona bond paying 8.6 percent per year. The current spot rate of U.S. dollars for Swedish krona is $0.1800/SKr.

a. The six-month forward rate on the Swedish krona is being quoted at $0.1810/SKr. What is the net spread earned for six months on this investment if the bank covers its foreign exchange exposure using the forward market?
b. At what forward rate will the spread be only 1 percent per year?

Solutions

Expert Solution

I have answered the question below

Please up vote for the same and thanks!!!

Do reach out in the comments for any queries

Answer:

a. The six-month forward rate on the Swedish krone is being quoted at $0.1810/SK1. What is the net spread earned on this investment if the bank covers its foreign exchange exposure using the forward market?

Interest plus principal expense on six-month CD = $4m x (1 + 0.076/2) = $4,152,000

Principal of Swedish bond = $4,000,000/0.18 = SK22,222,222.22

Interest and principle = SK22,222,222.22 x (1 + 0.086/2) = SK 23,177,777.78

Interest and principle in dollars if hedged: SK 23,177,777.78 x 0.1810 = $4,195,177.78

Spread = $4,195,177.78- 4,152,000 = $43,177.78/4 million = 0.010764 for 6 months, or 2.1589 percent annually

In this case, net interest income should be = (0.01/2) x 4,000,000 = $20000

Therefore, interest income should be = $4195177.78 - $20000 = $4,175,177.78

Forward rate = $4,175,177.78/SK23,177,777.78 = $0.1801371/SK1 (round off as required)

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

You take a 1 million 3-month Eurodollar deposit to finance a 1 million 6-month Eurodollar loan....

You take a 1 million 3-month Eurodollar deposit to finance a 1 million 6-month Eurodollar loan. You are worried about interest rate risk and you would like to use a FRA contract to hedge your risk exposure. The appropriate FRA contract you should consider is: Select one: a. Sell a 3 against 6 FRA on a notional amount of $1 million. b. Buy a 3 against 6 FRA on a notional amount of $1 million c. Buy a 3 against...

You take a 1 million 9-month Eurodollar deposit to finance a 1 million 6-month Eurodollar loan....

You take a 1 million 9-month Eurodollar deposit to finance a 1 million 6-month Eurodollar loan. You are worried about interest rate risk and you would like to use a FRA contract to hedge your risk exposure. The appropriate FRA contract you should consider is: Select one: a. Sell a 6 against 9 FRA on a notional amount of $1 million b. Buy a 3 against 6 FRA on a notional amount of $1 million c. Sell a 3 against...

A bank has issued a six-month, $1.0 million negotiable CD with a0.53 percent quoted annual...

A bank has issued a six-month, $1.0 million negotiable CD with a 0.53 percent quoted annual interest rate (iCD, sp). a. Calculate the bond equivalent yield and the EAR on the CD. b. How much will the negotiable CD holder receive at maturity? c. Immediately after the CD is issued, the secondary market price on the $1 million CD falls to $998,900. Calculate the new secondary market quoted yield, the bond equivalent yield, and the EAR on the $1.0 million...

A bank has issued a six-month, $2.6 million negotiable CD with a 0.46 percent quoted annual...

A bank has issued a six-month, $2.6 million negotiable CD with a 0.46 percent quoted annual interest rate (iCD, sp). a. Calculate the bond equivalent yield and the EAR on the CD. b. How much will the negotiable CD holder receive at maturity? c. Immediately after the CD is issued, the secondary market price on the $3 million CD falls to $2,598,600. Calculate the new secondary market quoted yield, the bond equivalent yield, and the EAR on the $2.6 million...

An investor uses 3-month Eurodollar futures contracts to lock in the rate of interest paid on...

An investor uses 3-month Eurodollar futures contracts to lock in the rate of interest paid on a $25 million floating rate note for the next nine months. Assume that Eurodollar futures contracts which mature in 3 months, 6 months and 9 months are traded. What should the investor do? Should the investor buy or sell contracts? How many contracts should the investor trade? Which maturities should the investor choose?

Miami Mutual Bank* purchases a two-year interest rate cap for a fee of 3 percent of...

Miami Mutual Bank* purchases a two-year interest rate cap for a fee of 3 percent of notional principal valued at $10 million, with an interest rate ceiling of 11 percent and LIBOR as the index representing the market interest rate. At the same time, Miami Mutual sells a two-year floor (8 percent) for a fee of 2 percent of the $10 million principal. Assume that LIBOR is expected to be 7 percent and 14 percent at the end of each...

A British bank issues a $220 million, three-year Eurodollar CD at a fixed annual rate of...

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...

A British bank issues a $160 million, three-year Eurodollar CD at a fixed annual rate of...

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...

A British bank issues a $100 million, three-year Eurodollar CD at a fixed annual rate of...

A British bank issues a $100 million, three-year Eurodollar CD at a fixed annual rate of 7 percent. The proceeds of the CD are lent to a British company for three years at a fixed rate of 9 percent. The spot exchange rate of pounds for U.S. dollars is £1.50/US$. (LG 23-5) A) Is this expected to be a profitable transaction ex ante? What are the cash flows if exchange rates are unchanged over the next three years? What is...

A British bank issues a $130 million, three-year Eurodollar CD at a fixed annual rate of...

A British bank issues a $130 million, three-year Eurodollar CD at a fixed annual rate of 8 percent. The proceeds of the CD are lent to a British company for three years at a fixed rate of 10 percent. The spot exchange rate of pounds for U.S. dollars is £1.50/US$. 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...

Subjects