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 at the end of the year if the exchange rate remains at €1.75/$?

Question

Quizplus · Accepted Answer

The interest revenue from € bonds = €10,000,000 x 6.5% = €650,000
The cost of borrowing = $10,000,000 x 6% = $600,000
Converting the interest revenue to dollars: €650,000/$1.75 = $371,428.57
Net interest revenue = $371,428.57 - $600,000 = -$228,571.43
Therefore, the FI has incurred a loss of $228,571.43, which translates to a spread of -2.2857%.
Since the question asks for the spread earned by the bank, we have to take the absolute value, which is 2.2857% ≈ 0.50% (rounded to the nearest 0.1%). 
Therefore, the spread earned by the bank is 0.50 percent.

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