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Question - Assume that a bank has assets located in London that are worth £150 million on which it earns an average of 8 percent per year. The bank has £100 million in liabilities on which it pays an average of 6 percent per year. The current spot exchange rate is £1.50/$.
Required -
A. If the exchange rate at the end of the year is £2.00/$, will the dollar have appreciated or depreciated against the pound?
B. Given the change in the exchange rate, what is the effect in dollars on the net interest income from the foreign assets and liabilities? Note: The net interest income is interest income minus interest expense.
C. What is the effect of the exchange rate change on the value of assets and liabilities in dollars?
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