Question

It is observed that currently the yields on CDs of identical risk with maturity of 274 (365-91) days in both Sterling and Euro-CD markets have risen to 8.4 per cent. (i) What is the current price of both CDs and (ii) the effective yield of the Euro CD?

face value on CDs is £1,000,00

Answer 1

A euro 1,000,000 CD will have a redemption value of principal plus 365 days interest. However the domestic CD will have accrued interest at the rate of actual/365 whereas euro CD will accrue interest at the rate of actual/360. Thus future value of each will be as follows:

FV CD = 1,000,000*{1+(0.084*365/365)} = 1084000

FV euro CD = 1,000,000*{(1+(0.084*365/360)} = 1085167

Effective yield of euro CD will be 8.4*365/360 = 8.52%

The current price of the two CD’s will be terminal values as calculated above discounted by 8.52% although effective yield of euro CD will be 8.52*(365/360) = 8.64%

P CD = 1084000

       {1+ (0.0852*274/365)}

= 1084000/ 1.063958

= 1018837

P euro CD = 1085167/{1+(0.0852*274/365)}

= 1085167/1.063958

= 1019934