An FI Has Purchased (Borrowed)a One-Year $10 Million Eurodollar Deposit

An FI has purchased (borrowed) a one-year $10 million Eurodollar deposit at an annual interest rate of 6 percent.It has invested these proceeds in one-year Euro (€) bonds at an annual rate of 6.5 percent after converting them at the current spot rate of €1.75/$.Both interest and principal are paid at the end of the year.

Assume that instead of investing in Euro bonds at a fixed rate of 6.5 percent,the FI invests them in variable rates of LIBOR + 1.5 percent,reset every six months.The current LIBOR rate is 5 percent.LIBOR at the end of six months is 5.5 percent.Assume both interest and principal will be reinvested in six months.Assume the spot exchange rate is €1.75/$.What should be the one-year forward rate in order for the bank to earn a spread of 1 percent?

A) €1.7344/$.
B) €1.7418/$.
C) €1.7478/$.
D) €1.7750/$.

Correct Answer:

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