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 if the bank can sell one-year forward Euros at €1.755/$?

Question

Quizplus · Accepted Answer

The spread is calculated by considering the interest earned on the Euro bonds, the interest paid on the Eurodollar deposit, and the exchange rate changes. The bank earns 6.5% on the Euro bonds and pays 6% on the Eurodollar deposit. The forward rate gain is calculated by converting the final Euro amount back to dollars at the forward rate. The net effect results in a spread of 0.20%.

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