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Suppose that a U.S. FI has the following assets and liabilities: Assets Liabilities $300 Million U.S. loans (one year), Loan made in dollar (7%) $500

Suppose that a U.S. FI has the following assets and liabilities: Assets Liabilities $300 Million U.S. loans (one year), Loan made in 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 percent, to be paid in dollars at the end of the year; the one-year default riskfree loans are yielding 7 percent in the United States; and one-year default riskfree loans are yielding 11 percent in the United Kingdom. The spot exchange rate of at the beginning of the year is $1.25/1 and at the end of 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, assume that the U.S. FI did not sign the contract of forward exchange rates. (4 marks) b. Calculate the net return for the U.S. FI over the year, assume that the U.S. FI signed a contract of one year forward exchange rate. (4 marks) c. Assume that the U.S. FI signed a contract of 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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