14-93 Assume that instead of investing in Euro bonds at a fixed rate of 6.5 percent,the FI invests them in variable rates of LIBOR + 1.5 percent,reset every six months.The current LIBOR rate is 5 percent.Assume both interest and principal will be reinvested in six months.Assume the exchange rate remains at €1.75/$ at the end of the year.What should be the LIBOR rates in six months in order for the bank to earn a 1 percent spread?
A)5.25 percent.
B)5.48 percent.
C)5.76 percent.
D)5.86 percent.
E)5.94 percent.

Question

Quizplus · Accepted Answer

To earn a 1% spread, the FI needs to earn a rate of 7.5% (6.5% fixed rate + 1% spread).

With the current LIBOR rate of 5%, the FI is earning a rate of 6.5% (5% + 1.5%).

So, in order to earn a total rate of 7.5%, the LIBOR rate needs to increase by 2 percentage points to offset the current spread of 1.5%.

Therefore, the required LIBOR rate in six months would be 5.76% (5% + 2% - 1.5%).

14-93 Assume That Instead of Investing in Euro Bonds at a Fixed