Question
Suppose that a U.S. FI has the following assets and liabilities: Assets Liabilities $300 Million U.S. loans (one year), Loan made in the dollar (7%)
Suppose that a U.S. FI has the following assets and liabilities: Assets Liabilities $300 Million U.S. loans (one year), Loan made in the dollar (7%) $500 million U.S. CDs (one year) in dollar (5%) $200 Million equivalent U. K. loans (one year), Loan made in pounds (11%) The promised one-year U.S. CD rate is 5 per cent, to be paid in dollars at the end of the year; the one-year default riskfree loans are yielding 7 per cent in the United States, and one-year default riskfree loans are yielding 11 per cent in the United Kingdom. The spot exchange rate of at the beginning of the year is $1.25/1 and at the end of the year is $1.15/1. The one-year forward exchange rate is $1.30/1. Required: a. Calculate the net return for the U.S. FI over the year, assuming that the U.S. FI did not sign the contract of forwarding exchange rates. (4 marks) b. Calculate the net return for the U.S. FI over the year, assuming that the U.S. FI signed a contract of the one-year forward exchange rate. (4 marks) c. Assume that the U.S. FI signed a contract of the one-year forward exchange rate. The FI funds the British loans with $200 million equivalent one-year pound CDs at a rate of 7 percent, and funds U.S. loans with $300 million one year U.S. CDs at a rate of 5 percent. Calculate the net return for the U.S. FI over the year. (4 marks) d. From this question, we can know that the return of the U.S. FIs investment is determined by exchange rate and interest rate. Please indicate which theory (theorem) you learnt in FIN925 that explains the relation between exchange rate and interest rate. What is the relation between exchange rate and interest rate in this theory? (2 marks)
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