North Bank has been borrowing
North Bank has been borrowing in the U.S. markets and lendingabroad, thereby incurring foreign exchange risk. In a recenttransaction, it issued a one-year $2.25 million CD at 4 percent andis planning to fund a loan in British pounds at 6 percent for a 2percent expected spread. The spot rate of U.S. dollars for Britishpounds is $1.4500/£1. a. However, new information now indicatesthat the British pound will appreciate such that the spot rate ofU.S. dollars for British pounds is $1.4300/£1 by year-end.Calculate the loan rate to maintain the 2 percent spread? (Do notround intermediate calculations. Round your answer to 2 decimalplaces. (e.g., 32.16)) Loan rate 0.55 % b. The bank has anopportunity to hedge using one-year forward contracts at 1.4600U.S. dollars for British pounds. Calculate the net interest marginif the bank hedges its forward foreign exchange exposure? (Do notround intermediate calculations. Round your answer to 2 decimalplaces. (e.g., 32.16)) Net interest margin % c. Calculate the loanrate to maintain the 2 percent spread if the bank intends to hedgeits exposure using the forward rates? (Do not round intermediatecalculations. Round your answer to 2 decimal places. (e.g., 32.16))Loan rate %
Answer:
Answer to question1.
Loan rate to maintain 2% spread :
Amount of loan = 2.25 million * 1.45
= 3.26
Interest and principal at year end : 3.26*1.06 = 3.46Million/1.4300
= $2419580. 42
Interest and principal of CD : 2.25Million * 1.04 = $2340000
Net Interest Income : $2419580.42 – 2340000
= $79580.42
Net Interest margin = $79580.42/2.25Million
= 3.54%
To maintain 2% Spread interest and prinicpal earned at 1.43 $should be :(2.39 – 2.34)/2.25 = 2%)
3.26(1+X)/1.43 =2.39
1+x = 2.39*1.43/3.26
= 1.04837
x = .04837 or 4.84%
Interest rate on Loan should be 4.84%
Question 2
Net Interest Marginif bank hedges its forward exchange exposure
Net Interest Income if Hedged : 3.26*1.06 = 3.46/1.46
= $2.37 m – 2.34m
= 0.03m /30000million
Net Interest Margin : $0.03/$2.25 = 1.33%
Question 3
Loan rate to maintain 2% spread to hedge theexposure
To maintain 2% spread : 3.26(1+x)/1.46 = 2.39
1+x = 2.39*1.46/3.26
1.070
X = 7.03%
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