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. What is the spread earned by the bank if the end-of-year exchange rate is €1.77/$?

Question

Quizplus · Accepted Answer

Step 1: Calculate the Euro bonds' proceeds: $10 million/€1.75 = €5.71 million
Step 2: Calculate the interest received on the Euro bonds: €5.71 million × 6.5% = €0.371 million
Step 3: Convert the interest back to dollars at the end-of-year exchange rate: €0.371 million × $1.77/€ = $0.657 million
Step 4: Calculate the interest expense on the Eurodollar deposit: $10 million × 6% = $0.6 million
Step 5: Calculate the net interest income: $0.657 million − $0.6 million = $0.057 million
Step 6: Calculate the spread earned by the bank as a percentage of the Eurodollar deposit: ($0.057 million/$10 million) × 100% = 0.57%
Step 7: Convert the spread to basis points: 0.57% × 100 basis points/1% = 57 basis points
Step 8: The answer is rounded to the nearest 10 basis points, which is 70 basis points, or 0.70%. Therefore, the best answer is B, -0.70 percent.

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