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.

At what one-year forward rate will the bank earn a 1 percent spread?

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.

At what one-year forward rate will the bank earn a 1 percent spread?

Quizplus · Accepted Answer

To earn a 1 percent spread, the dollar equivalent conversion should be $10,700,000
 U.S. Dollar spread = (10,700,000 - 10,600,000)/10,000,000 = 0.01
 Forward rate needs to be €18,637,500/$10,700,000 = €1.7418/$1.

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