Selena Gomez (SG) Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year, $2 million CD at 6% interest rate and funded a loan in euros at 8% interest rate. The spot rate for the euro was 1.45/$1 at the time of the transaction.

a. Information received immediately after the transaction closing indicated that the euro for dollar exchange rate will change to 1.47/$1 by year-end. If the information is correct, what will be the net return on the loan inclusive of principal? What should have been the bank interest rate on the loan to maintain the 2% net return?

b. The SG Bank had an opportunity to sell one-year forward euros at 1.46/$1. What would have been the net return on the loan if the bank had hedged forward its foreign exchange exposure?

c. What would have been an appropriate change in loan rates to maintain the 2% net return if the bank intended to hedge its exposure using forward contracts?