Problem. You manage a bank that 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 $5 million CD at 4% and is planning to fund a loan in Japanese yen at 6%. The spot rate USD/JPY is $0.00950/JPY. (a) The bank's FX department forecasts that the spot rate 1 year from now will be $0.009483/JPY. If they are correct, what rate should the bank charge on the loan to maintain the 2% spread? (b) The bank has been offered a forward contract at $0.009493/JPY. Assuming the bank keeps the loan rate at 6%, what is the spread if the bank uses the forward contract? (c) If the bank uses the forward contract, what rate on the loan is necessary to maintian a 2% spread? ASSUME THE LOAN ENDS AFTER ONE YEAR, SO THE PRINCIPAL WILL BE REPAID USD Given: CD amount US Dollars Rate on CD Spot rate 5/5 $/PY part(a) At the beginning: Amount of Yen to loan Profit in $ 2% spread means Sraised from depositors at the beginning 2% $ received from the loan - $ paid to depositors = 2% $from depositors at beginning One year later: Profit in Dollars needed for a 2% spread $ paid to depositors $ needed from the loan Spot rate $JPY Proceeds needed from the JPY loan in Yen Interest rate required on the JPY loan $/PY JPY $/PY JPY part (b) forward rate on the Yen loan Yen received from loan Convert to $ at forward rate $ paid to depositors Net dollars to the bank Spread part (c) One year later: Profit in Dollars needed for a 2% spread $ paid to depositors $ needed from the loan Forward rate Proceeds needed from the JPY loan in Yen Interest rate required on the PY loan $/APY JPY