A Swiss bank issues a $100 million, three-year Eurodollar CD at a fixed annual rate of 7 percent. The proceeds of the CD are lent to a Swiss company for three years at a fixed rate of 9 percent. The spot exchange rate is SF1.50/$.
a. Is this expected to be a profitable transaction?
b. What are the cash flows if exchange rates are unchanged over the next three years?
c. What is the risk exposure of the bank's underlying cash position?
d. How can the Swiss bank reduce that risk exposure?
e. If the US dollar is expected to appreciate against the SF to SF1.65/$, SF1.815/$, and SF2.00/$ over the next three years, respectively, what will be the cash flows on this transaction?
f. If the Swiss bank swaps US$ payments for SF payments at the current spot exchange rate, what are the cash flows on the swap? What are the cash flows on the entire hedged position? Assume that the U.S. dollar appreciates at the rates in part (e).
g. What are the cash flows on the swap and the hedged position if actual spot exchange rates are as follows:h. What would be the bank's risk exposure if the fixed-rate Swiss loan was financed with a floating rate U.S. $100 million, three-year Eurodollar CD?
i. What type(s) of hedge is appropriate if the Swiss bank in part (h) wants to reduce its risk exposure?
j. If the annual Eurodollar CD rate is set at LIBOR and LIBOR at the end of years 1, 2, and 3 is expected to be 7 percent, 8 percent, and 9 percent, respectively, what will be the cash flows on the bank's unhedged cash position? Assume no change in exchange rates.
k. What are the cash flows on the bank's unhedged cash position if exchange rates are as follows:
l. What are both the swap and total hedged position cash flows if the bank swaps out its floating rate US$ CD payments in exchange for 7.75 percent fixed-rate SF payments at the current spot exchange rate of SF1.50/$?
m. If forecasted interest rates are 7 percent, 10.14 percent, and 10.83 percent over the next three years, respectively, and exchange rates over the next years are those in part (k), calculate the cash flows on an 8.75 percent fixed-floating-rate swap of U.S. dollars to Swiss francs at SF1.50/$.