Question

1.

A bank purchases a six-month $2 million Eurodollar deposit at an interest rate of 7.4 percent per year. It invests the funds in a six- month Swedish krona bond paying 8.0 percent per year. The current spot rate of U.S. dollars for Swedish krona is $0.1790/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? (For all requirements, do not round intermediate calculations. Round your answers to 4 decimal places. (e.g., 32.1616)) % a. b. Net spread Forward rate per SK

Answer 1

Solution :-

The Value of $2 million Six months Euro Dollar Deposit = @7.4%

= $2000000 * 0.074 * 6 / 12 = $2074000

Current Spot Rate = 1Skr = 0.1790$

Now $2000000 = $2000000 / 0.1790 = Skr. 11173184.36

The Value of Skr Bond Deposit after 6 months @8%

= Skr 11173184.36 * 8% * 6/12 = Skr. 11620111.7

The Value of Six month Skr 11620111.7 at Six month Forward rate in Dollar

= Skr 11620111.7 * 01810 = $2103240.22

Now the Net Spread = $2103240.22 - $2074000 = $29240.223

Now The Spread % = $29240.223 / $2000000 = 1.46%

(b)

If spread is 1% per year so 0.5% for 6 months

then Spread amount = $2000000 * 0.5% = $10000

Means the amount received after 6 month converting Skr into $ = $10000 + $2074000 = $2084000

The Value of Skr deposit in Skr after 6 month = Skr. 11620111.7

Now Forward Rate for 1% spread =

Skr 1162111.7 * FR = $2084000

FR For 6 month = 1 Skr = 0.17933 $