FIM Bank is an Australian bank. The bankhas been borrowing in the Australian markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it borrowed $AUD 5 million via a one-year security at 4.5 per cent per annum nominal and funded a loan in Swiss Francs (CHF) at 5.0 per cent. The spot rate at the time of this transaction was 1.5152 AUD = 1 CHF(AUD/CHF = 1.5152).

(a)Information received immediately after the transaction closing indicated that the Swiss Franc would depreciate to AU$1.5102/CHF 1 by year end (i.e. 1.5102 AUD = 1 CHF). If the information is correct, what will be the realised spread on the loan? Assume adjustments in principal values are included in the spread.

(b)Suppose the bank had an opportunity to sell one-year forward Swiss Francs at AU$1.5121/CHF 1 (i.e. 1.5121 AUD = 1 CHF). What would have been the spread on the loan if the bank had hedged forward its foreign exchange exposure?

(c)Explain how forward and spot rates would both change in response to the spread calculated in part (b)? In your answer, explain what the final value of the spread would be after the adjustment in forward and spot rates.