Bank USA recently purchase $10million worth of euro denominated one-year CDs that pay 10% interest annually. The current spot rate of U.S. dollars for euros is $1.30/€1. Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro? What will be the return on the one-year CD if the dollars appreciates relative to the euro such that the spot rate of U.S. dollars for euros at the end of the year is $1.2/€1? What will be the return on the one-year CD if the dollars depreciates relative to the euro such that the spot rate of U.S. dollars for euro at the end of the year is $1.4/€1?
Bank USA recently purchase $10million worth of euro denominated one-year CDs that pay 10% interest annually. The current spot rate of U.S. dollars for euros is $1.30/€1. Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro? What will be the return on the one-year CD if the dollars appreciates relative to the euro such that the spot rate of U.S. dollars for euros at the end of the year is $1.2/€1? What will be the return on the one-year CD if the dollars depreciates relative to the euro such that the spot rate of U.S. dollars for euro at the end of the year is $1.4/€1?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Q3. Bank USA recently purchase $10million worth of euro denominated one-year CDs that pay 10% interest annually. The current spot rate of U.S. dollars for euros is $1.30/€1.
Is Bank USA exposed to an appreciation or depreciation of the dollar relative to the euro?
What will be the return on the one-year CD if the dollars appreciates relative to the euro such that the spot rate of U.S. dollars for euros at the end of the year is $1.2/€1?
What will be the return on the one-year CD if the dollars depreciates relative to the euro such that the spot rate of U.S. dollars for euro at the end of the year is $1.4/€1?
Expert Solution
Step 1
The Bank USA has purchased CDs that are denominated in Euro currency which implies that upon maturity of CDs, Bank USA can convert Euro into USD. This means that, Bank will be selling CDs denominated in Euro and purchase USD upon maturity.
Hence, depreciation in the value of Euro or appreciation in the value of USD will incur loss for Bank USA.
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