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

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/$?

Quizplus · Accepted Answer

11efba52_6db6_1a46_b77c_4bad9156a38c_TB1314_00 The spread earned by the bank is the difference between the interest earned on the Eurobonds and the interest paid on the Eurodollar deposit, expressed as a percentage of the dollar deposit amount.

Interest earned on Eurobonds = $10 million × 6.5% = $650,000

Interest paid on Eurodollar deposit = $10 million × 6% = $600,000

Spread = (Interest earned on Eurobonds - Interest paid on Eurodollar deposit)/ Dollar deposit amount

Spread = ($650,000 - $600,000)/$10 million = 0.05 = 0.50%

Therefore, the spread earned by the bank is 0.50 percent.

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