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 $2.50 million CD at 4 percent and is planning to fund a loan in British pounds at 7 percent for a 3 percent expected spread. The spot rate of U.S. dollars for British pounds is $1.440/£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 $1.43/1 by year-end. Calculate the loan rate to maintain the 3 percent spread b. The bank has an opportunity to hedge using one-year forward contracts at 1.46 US dollars for British pounds. Calculate the net interest margin if the bank hedges its forward foreign exchange exposure. c. Calculate the loan rate to maintain the 3 percent spread if the bank intends to hedge its exposure using the forward rates. (For all requirements, do not round Intermediate calculations. Round your answers to 2 decimal places. (e.g.. 32.16)) Answer is complete but not entirely correct. Loan rate Net interest margin 7.75 112,153.00 5.50 3 % % Loan rate

Answer 1

So here you have shown that you have successfully answer a and c So I am just providing answer of part b:-

First of let's find out amount of load given :- 2500000$

According to spot rate

Amount of loan in £?? :- 2500000/1.44= 1736111

Amount of interest earned in £:- 1736111*0.07 = 121528£

Amount of interest in $ (forward rate 1.46$/£):- 177431$

Amount of interest paid in $ :- 2500000*0.04 = 100000$

INTEREST Margin :-(177431-100000)= 77431$

Interest Margin%:- 77431*100/2500000 = 3.10%

I hope my efforts will be fruitful to you.....

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