North Bank has been borrowing in the U.S. markets and lending abroad, thereby in
ID: 2780719 • Letter: N
Question
North Bank 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 $1.40 million CD at 5 percent and is planning to fund a loan in British pounds at 9 percent for a 4 percent expected spread. The spot rate of U.S. dollars for British pounds is $1.4540/£1. a. However, new information now indicates that the British pound will appreciate such that the spot rate of U.S. dollars for British pounds is $1.4300/E1 by year-end. Calculate the loan rate to maintain the 4 percent spread? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Loan rate b. The bank has an opportunity to hedge using one-year forward contracts at 1.4600 U.S. dollars for British (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Net interest margin c. Calculate the loan rate to maintain the 4 percent spread if the bank intends to hedge its exposure using the forward rates? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Loan rateExplanation / Answer
Total loan in $= $1.4 Mn
Loan in pounds = Loan in $ / Spot rate in dollars/pounds = $1.4 Mn /$1.454 per pound = 962861.073 pounds
Interest and Principal at end of year = Loan in pounds * (1+ loan interest rate) = 962861.073 * 1.09 pounds = 1049518.57 pounds
Conversion of amount to dollars = 1049518.57 pounds * $1.43 per pound = $1500811.554
Interest and principal from CDs = loan in dollars * ( 1+ CD rate) = $1.4 Mn * 1.05 = $1.47 Mn
Net Income = $1500811.554 - $1470000 = $30811.554
Net Interest Margin = $30811.554 / $1.4 Mn = 0.02200825 = 2.2008%
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4% = X - $1.47 Mn / $1.4 Mn where X = $1.526 Mn
In order to maintaina 4% spread, interest and principal earned at a spt rate of 1.43 pounds /dollar will be
= 962861.073 pounds * (1+r ) * 1.43 = $1.526 Mn (from above equation)
Above equations yields r = 0.108294 = 10.83%
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Net interest income if hedged = 1049518.57 pounds * 1.46 dollars per pound - $1470000 = $62297.11
Net interest margin = $62297.11/ $1.4 Mn = 0.044497 = 4.45%
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4% = X - $1.47 Mn / $1.4 Mn where X = $1.526 Mn
In order to maintaina 4% spread, interest and principal earned at a spt rate of 1.46 pounds /dollar will be
= 962861.073 pounds * (1+r ) * 1.46 = $1.526 Mn (from above equation)
Above equation gives r = 0.0855 = 8.55%
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