1. East 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 $3 million CD at 5% and is planning to fund a loan in British pounds (equivalent to $3 million) at 7% for a 2% spread. The spot rate of U.S. dollars for British pounds is $1.40/1.

a. New information indicates that the British pound will appreciate such that the spot rate of U.S. dollars for British pounds is $1.35/1 by year-end. What will the spread be, given this information?

b. Suppose the bank has an opportunity to hedge using one-year forward contracts at $1.42 U.S. dollars for British pounds. What is the spread if the bank hedges its forward foreign exchange exposure?