The bankhas been borrowing in the Australian markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it borrowed $AUD 50 million via a one-year security at 5.5 per cent per annum nominal and funded a loan in New Zealand Dollars (NZD) at 7.5 per cent. The spot rate at the time of this transaction was 1 AUD = 1.0588 NZD(NZD/AUD = 1.0588).

(a)Information received immediately after the transaction closing indicated that the New Zealand dollar would depreciate to NZD$1.0656/AUD 1 by year end (i.e. 1.0656 NZD = 1 AUD). 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 New Zealand Dollars at NZD$1.0687/AUD 1 (i.e. 1.0687 NZD = 1 AUD). What would have been the spread on the loan if the bank had hedged forward its foreign exchange exposure?

(c)According to the Interest Rate Parity Theorem (IRPT), in equilibrium, what should the spread in part (b) have been equal to?Assuming equilibrium and that the IRPT holds, calculate what the forward rate in part (b) should have been equal to.