Reference no: EM132461463

Problem - A British bank issues a $300 million, three-year Eurodollar CD at a fixed annual rate of 9 percent. The proceeds of the CD are lent to a British company for three years at a fixed rate of 11 percent. The spot exchange rate of pounds for U.S. dollars is £1.50/US$.

Required -

1. Is this expected to be a profitable transaction ex ante?

2. What are the cash flows if exchange rates are unchanged over the next three years?

3. If the U.S. dollar is expected to appreciate against the pound to ELSE/$1, £1.815/$1, and £2.00/$1 over the next three years, respectively, what will be the cash flows on this transaction?

4. If the British bank swaps U.S. dollar payments for British pound payments at the current spot exchange rate, what are the cash flows on the swap and on the entire hedged position? Assume that the U.S. dollar appreciates at the same rates as in part (3).