Question

Suppose that a U.S. FI has the following assets and liabilities:

Assets	Liabilities
$400 million U.S. loans  (one year) in dollars	$500 million U.S. CDs  (one year) in dollars
$100 million equivalent German  loans (one year) (loans made in euros)

The promised one-year U.S. CD rate is 2 percent, to be paid in dollars at the end of the year; one-year, default risk–free loans in the United States are yielding 4 percent; and default risk–free one-year loans are yielding 5 percent in Germany. The exchange rate of dollars for euros at the beginning of the year is $1.25/£1.

Calculate the net interest margin for the FI if the spot foreign exchange rate falls to $1.15/€1 over the year.

Answer 1

Out of 500,

400 million is invested in US loans (which is aroun 80% of total)

100 million is invested in German loans (which is around 20% of total)

• Sells $100 million for pounds, which would be 100/1.25 (= € 80 million)
• Lend the sum @5% for one year, it will be € 80 million * 1.05 = € 84million
• Dollar proceed from German Loan = € 84 million*1.15 = $ 96.6 million (exchange rate changed $1.30/1€ )
• Return on German Loan= (96.6 - 100)*100/100 = .-3.4%
• Return On US loan = 4%
• Weightage return on FI's investment portfolio = .80 * 4 + .20* -3.6 = 3.2 - 0.72 =2.48
• Net return for the FI= 2.48 - 2 = 0.48 % Answer

c.